Marcus & Millichap

Retail Spotlight

May 2018

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New Tax Rules Could Inspire Strategy Change for Owner-Users; Additional Sale-Leaseback Investments Could Surface

New tax rules motivate restaurant and retail owners to pursue sale-leaseback. The convergence of several factors has increased the appeal of sale-leaseback options for companies that own and occupy retail space. The evolving retail climate has pressured many retailers to adopt creative strategies to increase their profitability. Under the old tax rules, some business owners preferred to lock in their costs by purchasing the real estate in which they operate, but this could change under the new tax law. Previously, companies could deduct all of their interest expenses on their taxes, but the new provisions restrict the deductibility of business interest for companies with gross receipts in excess of $25 million. Now interest totaling just 30 percent of earnings before taxes, depreciation and amortization can be deducted on taxes. As a result, businesses may shift strategies and sell the real estate in which they operate to investors and lease it back from them. This eliminates the interest expense of the mortgage tied to the real estate and transforms that cost into a lease, which is generally fully deductible. Because sale-leasebacks often have extended lease terms and allow the seller-turned-tenant to maintain the property, there are few operational differences. As an added benefit for the seller, this process also unlocks the equity of the property, providing additional capital to grow operations.

Retail metrics continue to strengthen, attracting a diverse pool of investors. Last year, the U.S. single-tenant vacancy rate decreased 10 basis points to 4.5 percent, the lowest rate in more than a decade and down 260 basis points from the high recorded in 2009. Tempered development compared to the prior business cycle has contributed to single-tenant retail’s tight market conditions. Rents have moved in accordance by increasing steadily in the past five years, posting cycle-high growth of 4.6 percent in 2017 and placing the average asking rent at $20.35 per square foot. Looking ahead, fundamentals in the single-tenant retail sector appear favorable through this year, as the national vacancy rate is forecast to decline 10 basis points in 2018, supporting an anticipated 3.7 percent increase to the average asking rent.

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