The Los Angeles Times today has an interesting article about a pending lawsuit from a group of investors against Marcus & Millichap and two businessmen who operated franchises of Church’s Chicken and Jiffy Lube. The parties are accused of the classic “pump and dump” scheme whereby franchisees artificially inflate their rent so they can achieve higher real estate values upon sale to an investor. After the sale is complete, the franchisee operator simply runs the business into the ground and closes up shop or even worse, the franchisee will sell the business to a new operator. The franchisee has now cashed out twice – once upon the sale of the real estate and again upon the sale of the business. Unfortunately, most of the time, the new business owner has no clue that the contract rent he has inherited is not sustainable based on the performance of the business. The new owner is ultimately forced to shut down, Now two people are screwed – the owner of the real estate and the new owner of the business.
This is exactly the reason why I hate sale/leaseback transactions. Unless an investor is very familiar with the operator/tenant, understands the tenant’s performance at the subject location and its relationship to contract rent and ultimately love the location of the property, investors should stay away from sale/leaseback opportunities as they can be disastrous.
One recent example comes to mind when I think of sale/leaseback disasters. A little over a year ago IndyMac Bank put out a large portfolio of sale/leaseback opportunities. All properties (at least in California) were priced in the mid-5% CAP Rate range. I’m quite sure the owners of those properties did not realize they were providing life support in the form of short-term operating capital at the time of their purchase.
Sale/leaseback opportunities need to be analyzed for what they are: a corporate finance vehicle. Once an investor gets past the tenant due diligence and underwriting, only then should they move on to looking at the intrinsics of the real estate.
2 comments
Lucas says:
February 6, 2009 at 10:45 pm (UTC -8)
Sale/Leasebacks always worry me as well. Look at Shane Co…they did this to all of their buildings…and now they are filling for bankruptcy etc. I wonder about Pep Boys and about all their Sale/leasebacks and how they are playing into the company's future.
Chris Rodriguez says:
February 8, 2009 at 6:54 pm (UTC -8)
Pep Boys is another great example. That cash is for life support.