In 2018, Marcus & Millichap reported that federal tax changes would encourage retail and restaurant owners to pursue sale-leasebacks. Let’s see why Chili's is among several national restaurant chains who has shifted to this new strategy.
Some major chain restaurants across the country are selling their real estate and leasing the space back, investing the equity in their businesses as they adjust to a tax law change that trims deductions on owned property.
In the past six months alone at least $500 million in restaurant sale-leaseback deals, involving national chains such as Chili’s, Pizza Hut and Outback Steakhouse, were signed across the United States.
Prominent retail store chains, including grocery stores, also have been selling and leasing back multiple U.S. locations in recent years.
Sale-leasebacks allow restaurant operators to recapture capital that they’ve invested into their real estate, and put it toward other areas of their business, including opening new locations, remodeling their eateries or paying down debt.
The restaurant operator can also negotiate rent terms that are affordable in the long run under the new building owner.
The largest U.S. franchisees of Pizza Hut -- owned by Louisville, Kentucky-based Yum! Brands Inc. has done several sale-leaseback transactions involving 82 Pizza Huts in seven Western and Midwestern states.
Pizza Hut announced plans to expand internationally last year and is focused on growing its beer delivery service in the United States.
In addition to paint retailer Sherwin-Williams, convenience-store operator 7-Eleven, and supermarket owners Supervalu and Albertsons.
While the sale-leaseback phenomenon isn't new, the stage is set for further growth of such deals following recent changes in tax laws.
Brokerage firm Marcus & Millichap noted in a 2018 report that changes in federal tax rules, among other factors, have encouraged a growing number of retail and restaurant owners to pursue sale-leaseback deals, especially as the overall retail climate has become more challenging.
Prior to tax changes that took effect in early 2018, some business owners preferred to lock in costs by purchasing the real estate in which they operate, and tax laws allowed them to deduct all interest expenses related to those building purchases.
When the tax laws changed, that interest deductibility, for companies with annual gross receipts of more than $25 million, was reduced to an amount representing no more than 30 percent of earnings before taxes, depreciation and amortization.
"As a result, businesses may shift strategies and sell the real estate in which they operate to investors and lease it back from them," the Marcus & Millichap report said. This eliminates the interest expense tied to a mortgage. The cost then becomes a lease expense, which generally remains fully deductible.
Marcus & Millichap noted that as long as U.S. single-tenant retail vacancies remain at historically low levels, as they did in 2017 and 2018, and new retail development remains relatively scarce amid rising rents, a diverse pool of investors is likely to be attracted to sale-leaseback arrangements.