Sale-leaseback offered to me on an auto parts box by a non-rated regional operator. Unit economics look better than the credit

I do land and long holds, so this is off my usual path, and that's exactly why I want other eyes on it.

A regional auto parts operator with 31 stores across two states approached my broker about a sale-leaseback on four of their locations. I've been offered one, an 7,400 square foot box on a commercial corridor in a county seat of about 22,000, 1.1 acres, hard corner, 14,000 vehicles a day per the state DOT count.

Terms they're proposing: 20 year primary, 1.5 percent annual bumps, true triple net including roof and structure, price 1.34m, rent 100,500, so 7.5 percent. They've offered a corporate guarantee from the parent operating company. No rating, private, family held, no public filings. They gave me three years of consolidated statements and, unusually, they gave me store level P and L for the specific unit.

That unit did 2.71m in sales last year and 341,000 of four-wall EBITDAR. Rent coverage on the proposed rent is 3.4x. Consolidated, the company has a debt to EBITDA around 3.1 with about 40 percent of that being existing equipment and floor plan debt.

The tension. Every piece of NNN guidance says the credit is the deal and I'm being asked to accept a credit I can't independently verify against a lease priced maybe 75 to 100 basis points inside where I'd expect unrated regional operators to trade. They're setting rent at what looks to me like a deliberately affordable number rather than maxing proceeds, which usually signals they intend to stay.

What I can't decide is how much weight the 3.4x unit coverage should carry against the absence of any rating, and whether I should be asking for a lease structure that protects me instead of a discount.

Answer

2ehernandez74PO2BPRO5

I'd put the weight roughly where you already suspect it belongs, on the coverage, but I'd want the lease to carry the credit risk you can't underwrite from the statements.

Things I'd ask for, and they cost the seller nothing if they mean to stay. First, an ongoing financial reporting covenant, both consolidated and unit level, annually with a deadline and a default remedy if they miss it. You got the numbers once during diligence and then never again unless the lease says otherwise. Second, a rent coverage floor. If unit coverage drops below something like 1.75x for two consecutive years, you get additional security, an extra deposit or a letter of credit stepped up. Third, no assignment without consent to an entity of lesser net worth, with the parent guarantee surviving any assignment.

The piece I'd fight hardest for is a right of first refusal on the other three locations, priced at the same coverage math. If they perform for four years and stay, you've built a small portfolio with an operator you now actually know, and that diversification is the only real answer to concentration risk on an unrated tenant. One unrated box is a bet. Four across two states with staggered expirations is a position.

On the 75 to 100 basis points. I wouldn't chase it. Take the structure instead. A discount pays you once at closing and a reporting covenant pays you every year you hold, which for me is the whole hold. If they won't give reporting on a lease they wrote themselves, that refusal is the diligence answer.

3 replies

2kevin_lombardPG1BPRO5

Before I say anything useful I want to make sure I've got the basic tension straight, because this thread took me two passes.

A sale-leaseback means the company that operates out of the building sells you the building and then rents it back from you, so they get cash out of real estate they were sitting on and keep running the store. Is the reason people watch these carefully that the seller sets the rent themselves, and they have an incentive to set it high because higher rent means a higher sale price at any given cap rate?

If that's right, then parcel's operator setting rent low is the opposite of the worry, and the 3.4x coverage is them showing their work. What I don't understand is why the corporate guarantee matters so much if the individual store is that profitable. If the parent went under, wouldn't a store doing 2.7m in sales just get bought by someone?

2Rena Expert

juniper has the mechanism right. In a sale-leaseback the seller writes both sides of the trade, so above-market rent inflates the sale price and leaves the buyer holding a lease no replacement tenant would sign. That is the standard failure mode and it is why unit-level rent coverage is the number that matters more than the going-in cap rate.

On why the guarantee still matters when the store is profitable. In a bankruptcy the operator gets to decide which leases to assume and which to reject, subject to court approval, and that decision is made on the lease economics rather than on whether you were a reasonable landlord. A below-market lease on a profitable store is likely to be assumed or assigned to a buyer, which is the outcome you want. A rejected lease leaves you with a damages claim that is capped by statute and typically pays cents. How those rules apply to any particular filing depends on the chapter and the facts, so that is a bankruptcy counsel question before you sign.

For parcel, the two numbers to reconcile are the 3.4x coverage and the rent per foot. 100,500 on 7,400 feet is $13.58. Ask what second generation retail on that corridor actually leases for. If the answer is nine or ten, your coverage cushion is real and your re-lease downside is a 25 to 30 percent rent cut, survivable. If market is six, the coverage tells you the store is good and the lease is still mispriced.

Also ask why they are selling four rather than all 31, and what the proceeds fund. The use of proceeds tells you more about the credit than the consolidated statements will.