Sharing the Benefits of Credit Union Sale-Leasebacks

In prior CU Times articles, we have written about the core benefits for credit unions of sale-leasebacks of their owned operating real estate – receipt at closing of the entire profit (the excess of the sale price over depreciated book value), tax-free, which boosts liquidity, current year ROA and permanent capital, all while retaining uninterrupted use and control of the facilities. Traditionally, the financial benefits of the transaction were limited to the credit union itself, by way enhancing its financial condition and ability to grow lending and investments in technology, operations and CUSO-based ancillary business lines. Here, we’ll focus on a potential additional benefit of sale-leasebacks – the ability to permit credit union senior management and/or CUSO wealth management clients to share in the financial benefits on the buyer/investor side of the transaction.

Expanding Equity Participation in CU Sale-Leasebacks

In a typical sale-leaseback, the buyer/investor obtains its equity funding from sources unrelated to the seller/tenant. Those equity sources customarily are affluent individuals/family offices and private or public real estate funds with a focus on stabilized office buildings with investment-grade credit tenants. While such traditional investors will remain dominant in the emerging credit union sale leaseback space, there are two additional groups that can under proper conditions also participate as equity investors in such transactions – members of the selling credit union’s board of directors/senior management and clients of the selling CU’s wealth management CUSO. We consider in turn issues specific to each group.

CU Management Equity Participation

An ongoing challenge for credit union talent acquisition and retention is non-salary/bonus incentives. As member cooperatives, credit unions don’t have stock or other equity interests to award top management. Although some supplemental incentive arrangements are available, most notably collateral assignment split dollar life insurance and Section 457(f) deferred compensation plans, which are in fact widely used by larger credit unions, those plans can be subject to legal investment limits and may be affected adversely by fluctuations in interest rates, and equity and debt markets. Consequently, many credit unions remain on the lookout for additional ways to attract and retain key talent.

One potential addition to the key executive reward toolbox involves sale-leaseback transactions.  Here’s how it can work: When arranging a sale-leaseback that makes financial sense for the credit union, one term of the deal becomes the ability of identified members of management to invest in the buyer entity, on the same terms, including unit price, as all other investors. This is expressly permitted by the NCUA for federal credit unions. State chartered credit unions not covered by full and automatic parity rules will need to confirm local regulatory compliance. This of course requires additional best practices to avoid conflicts of interest in structuring the transaction, such as especially careful, independent valuation of the property and the related lease terms, including the triple net rent; ensuring that credit union management investors in the buyer entity do not control the buyer, but are merely passive co-owners; experienced external business and legal transaction advisors to the credit union, retained by and reporting directly to the credit union board or a special board committee with no buyer-side participants, to structure, negotiate and document the sale leaseback; and full disclosure to the credit union board and, if applicable, the credit union regulator of the extent of management (including family) participation in the buyer entity. Most of these features will be present in a standard sale-leaseback transaction, with no credit union management involvement on the buyer/investor side, but the latter aspect will require enhanced care and transparency.

If the above transactional best practices are followed, a sale-leaseback not only will provide the full range of customary benefits to the seller/tenant credit union, it also will grant participating credit union management a special investment opportunity that offers both a predictable and secure income stream from the triple net lease (where the tenant credit union bears all property-related expenses, including structural matters), and a capital gain when the property eventually is sold. Granular details include the buyer/investor’s willingness to include credit union management in its ownership group (as that creates certain legal complexities), getting the credit union board comfortable with the potential conflict of interest and the means to alleviate it, and how those credit union management members investing in the deal will obtain their funds.  Once those deal-specific issues are addressed, limited credit union management participation on the buy side of a sale-leaseback adds a win-win aspect to an already compelling story.

CU Select Member Equity Participation

For the same reasons members of credit union management might wish to invest in the buyer side of a sale leaseback, a credit union’s wealth management CUSO could find a proposed transaction attractive as part of the diversified investment portfolio of many of its clients.  Accordingly, a credit union might condition its willingness to undertake a sale-leaseback transaction on the buyer’s willingness to include certain CUSO investment clients as passive co-owners in the buyer entity. Here the legal issues turn on the fiduciary duty of the CUSO in its role as investment advisor, both in assessing the merits of the basic transaction and in addressing any conflict of interest concerns, which might require an independent assessment of the transaction by a special external advisor. Such issues will require individualized consideration, but there is no blanket ban on such investments. As we’ve explained above, credit union sale leaseback transactions offer attractive, secure investment returns over an extended period.

Sale Leasebacks Remain an Attractive Opportunity

The commercial real estate market is in a period of disruption right now, with sharply increased interest rates and other perceived market risks boosting the returns (“cap rates”) required by investors in commercial real estate from the mid 4% range to 8% or more. This translates to a reduced sale price for a given agreed annual rent. This may delay transactions but will not in the medium- to long-term eliminate them because of their compelling fundamental benefit as liquidity, profit and capital boosters. Further, where credit union management and/or wealth management CUSO clients can participate on the buyer side, the higher notional returns prevailing at the moment are at least mitigated as barriers to current deal-making.

To recap, sale-leasebacks allow credit unions to enhance income (both the current gain from the sale plus ongoing increased interest income from the additional lending capacity created), all while boosting liquidity and permanent capital. By leasing back the facility, the credit union maintains uninterrupted operations and control for a lease term negotiated to suit its long-term occupancy preferences, typically 20 or more years, including extension options. Main office or operations facilities remain the preferred asset, but branches also can be included, with the deal  structured as a single transaction or as a series of separate multi-location transactions phased over several years to create a predictable, annuity-like impact on financial performance.

The impact of a sale-leaseback transaction is synergistic. Shared value is created by shifting property ownership to investors who can utilize various tax benefits (including expanded depreciation write-offs and lower effective tax rates) that the credit union cannot enjoy. There are accounting, legal and regulatory issues that require the credit union’s attention, but they are readily manageable. So, when you think about how a sale-leaseback may benefit your credit union, expand your focus to consider potential additional benefits to your management team and/or the clients of any wealth management CUSO you have.

Ed Lopes is the CEO of CU Real Estate Solutions, LLC (CURES), a Boston-based real estate services and investment company that is focused solely on sale-leasebacks for credit unions.

Steve Eimert is an attorney who has represented credit unions nationwide in a variety of matters, including compliance, CUSOs and executive compensation, and is a co-founder and general counsel of CURES.