How do you treat sale-leaseback proceeds in underwriting?
Underwrite a sale-leaseback (SLB) — a deal where a company sells a property it owns and signs a long-term lease to stay in it — off historical financials first, then build a pro forma that reflects the tenant's stated use of proceeds. Do not accept that use on faith. Make it a closing condition and verify it. Propose the adjustment; commit only to what the documents prove.
The mistake sits at both extremes. Underwrite strictly off trailing statements and you ignore a real event: a company receiving, say, $10 million and paying down debt genuinely lowers interest expense and improves coverage. Credit the full pro forma benefit on a slide, though, and you have underwritten a promise — the borrower keeps the cash, or spends it on growth, and your coverage math was fiction from day one.
Sale-leasebacks are not a fringe structure. According to SLB Capital Advisors, U.S. and European sale-leaseback investment volume has run in the tens of billions of dollars annually in recent years, and CBRE has tracked net-lease investment volume in the tens of billions per quarter at market peaks. That is a large enough asset class that the underwriting convention matters.
The sequence that holds up
- Anchor on history. Spread three to five years of statements. Calculate baseline coverage as reported, before any transaction adjustment.
- Model the pro forma. Adjust the balance sheet and interest expense for the intended use of proceeds — debt paydown, capex, an acquisition — and recompute coverage.
- Show both. Present as-reported and pro forma side by side. A credit that only clears on the pro forma is a weaker credit, and your investment committee should see that plainly.
- Condition and verify. If the pro forma benefit is material, make the stated use a closing condition — a debt paydown at or near funding, evidenced by payoff letters. Anything you cannot verify stays out of the ratios.
Which coverage ratios actually decide the deal?
Three metrics carry most of the weight in an SLB credit: fixed charge coverage, rent coverage, and leverage. Rating agencies and net-lease lenders lean hardest on FCCR and rent coverage because they measure the tenant's ability to pay this rent out of operating cash flow, not out of one-time transaction proceeds.
- FCCR (fixed charge coverage ratio) — (EBITDA minus unfinanced capex and cash taxes) divided by fixed charges (interest plus scheduled principal plus rent). It answers whether recurring cash flow covers recurring obligations.
- Rent coverage — EBITDAR (earnings before interest, taxes, depreciation, amortization, and rent) divided by rent. Adding rent back isolates the tenant's ability to service the lease specifically.
- Leverage — total debt to EBITDA, which the proceeds most directly change when used for paydown.
Net-lease and private-credit underwriters commonly want rent or fixed-charge coverage of at least 1.5x–2.0x on a single-tenant credit, with investment-grade or strong sub-investment-grade tenants at the higher end and thinner deals scrutinized or repriced. Treat those thresholds as the market convention, not a law — the covenant package and lease term matter alongside the ratio.
Where the proceeds land determines which ratio moves. Debt paydown improves FCCR and leverage by cutting interest and principal. It does little to rent coverage, since EBITDAR already adds rent back. If the whole credit case depends on a paydown you have not confirmed, you are leaning on the one adjustment most easily reversed after closing.
Should you underwrite off history or a post-closing pro forma?
Do both, and label them honestly. History is the verifiable floor; the pro forma is a proposal about the future that only becomes real if you condition on it. The discipline is refusing to blur the two.
Historical statements are the audited, un-arguable base case. They tell you what the business did before the transaction touched the balance sheet. Start there so your committee sees the credit as it exists today, not as management hopes it will look.
The pro forma is where the sale proceeds enter — and where judgment is required:
- Debt paydown is the cleanest adjustment. Reduce debt, cut interest expense at the stated rate, recompute FCCR and leverage. Verifiable with payoff letters at close.
- Growth capex or an acquisition is harder. New assets may raise EBITDA, but the timing is uncertain and the benefit is not yet earned. Haircut it or exclude it.
- Cash held on the balance sheet improves liquidity but does nothing for recurring coverage. Note it; do not run it through the ratio.
The governing rule: an adjustment you can make a closing condition can go in the pro forma. An adjustment that rests on a plan can be shown as a sensitivity but should not carry the credit.
Can you tell the tenant what to do with the cash?
Yes — through the deal terms, not through instructions. You cannot direct a company's treasury, but as the buyer and landlord you set conditions to closing, and use of proceeds is a legitimate one. If your credit case assumes a debt paydown, write the paydown into the conditions and confirm it before you fund.
This is where the SLB seller's motive and yours can diverge. The tenant may want maximum flexibility with the cash; your underwriting may assume a specific use. Naming the assumption in the documents resolves the gap. Common mechanisms:
- Use-of-proceeds condition — funding is contingent on a defined use, evidenced at close.
- Financial covenants — ongoing minimum FCCR or maximum leverage tests that constrain what the tenant does afterward.
- Reporting requirements — periodic financials so coverage can be monitored over the lease term, not just at signing.
Net-lease defaults are not hypothetical — even long-dated, well-rated single-tenant leases carry credit risk over 10–15 year terms, and Moody's and S&P publish corporate default and recovery data that underwriters use to size that risk. The point of conditioning and covenanting is to keep the credit you underwrote intact after the ink dries.
The through-line: propose, then verify
The healthiest SLB underwriting treats the pro forma the way governed software treats any consequential action — it proposes, it does not commit. The system stages the adjustment; a human confirms it against documents; the record shows what was verified versus assumed.
That is the honest way to incorporate transaction proceeds. Model the intended use so you are not ignoring a real event. Then verify it as a closing condition so you are not underwriting a promise. Both numbers on the page, clearly labeled, and the credit resting on the one you can prove.
FAQ
What is a normal rent coverage ratio for a sale-leaseback?
Net-lease and private-credit underwriters commonly target rent or fixed-charge coverage of roughly 1.5x–2.0x on single-tenant credits, with stronger tenants at the higher end. It is a market convention, not a fixed rule — lease term, tenant credit quality, and the covenant package move the acceptable threshold.
Do sale-leaseback proceeds count as debt?
No. Under a properly structured SLB the tenant sells the asset and leases it back, so the transaction typically appears as rent (a fixed charge in coverage ratios), not as balance-sheet debt. Note that accounting treatment under current lease standards can require a right-of-use asset and lease liability, so confirm the tenant's reporting rather than assuming.
What cap rate is typical on a sale-leaseback?
Cap rates on net-lease sale-leasebacks vary widely by tenant credit, lease term, and asset type, and move with interest rates. Investment-grade, long-term deals price tighter; weaker credits and shorter terms price wider. CBRE and other brokerages publish periodic net-lease cap rate data — use a current market source rather than a fixed number.
Should you underwrite a sale-leaseback off historical or pro forma financials?
Both. Anchor on historical statements as the verifiable base case, then build a post-closing pro forma reflecting the tenant's stated use of proceeds. Present them side by side, and only credit pro forma benefits — like a debt paydown — that you can make a closing condition and verify with documents.