Sale-Leaseback: Your Guide to Unlocking Home Equity

Selling your home often involves a lengthy and uncertain search for a new one that fits your needs. It can also be an emotional process if you’re selling because you have to, and then a stressful one when you have to move — which only gets more complicated with age. 

With a sale-leaseback arrangement, you can sell your home, unlock the equity you’ve put into it, and continue living there without taking on more debt. To help you make an informed decision, you should understand as much as possible about sale-leasebacks to determine if they’re right for you. 

Let’s get started!

What Is a Sale-Leaseback Agreement?

A sale-leaseback (or sale and leaseback) is an agreement where you sell your house to a new owner, then without moving out, you lease it back and make rent payments to that new owner. This means you can use the money you made from the sale for other things.

To better understand what a sale-leaseback is, let’s discuss where they came from.

Sale-leaseback transactions originated in commercial real estate as a means of giving business owners the ability to relieve debt and liquidate equity on their property. Typical sale-leaseback agreements give businesses the ability to continue operating in their space without the responsibility of owning it while using their freed-up capital for reinvestment.

For example, let’s say your company specializes in kitchen and bathroom remodeling, and you own a building to house your inventory and build cabinets and countertops on-site. Business is going well, but you need to buy more materials to keep up with demand. You could take out a short-term loan, but many of them have high interest rates. You could sell the building, but then you have to find a new one, and relocating is expensive.

Instead, you can sell your building to a real estate investment company, then sign a long-term lease agreement with them. Now, you continue operating in the same space, and you can buy more inventory with the money you made from the sale.

Sale-Leaseback Transactions for Residential Real Estate

What started as a novel idea for businesses has crossed over to the residential real estate market.

Between the recession, inflation, the ever-changing cost of homes, and general economic uncertainty, many homeowners are looking for additional ways to make money to get by. Some people are downsizing, while others rent out portions of their homes for an extra income stream.

A sale-leaseback transaction is another way to get additional funds without moving or becoming a landlord. Sale-leasebacks free you from some unwanted burdens of homeownership (e.g., being responsible for renovations, paying property taxes, etc.) while allowing you to continue living in your home and receiving all of the equity you accrued while paying down your principal.

With the extra cash in hand, you can do whatever you want, like invest in a new business, pay off unwanted debts, or even travel the world.

How Do Sale-Leaseback Transactions Work?

Here’s a real-world example of how this transaction works:

Daryl wants to retire early and continue living in his home, but he’s about $400,000 short of being financially independent. The purchase price for his home in the Bay Area was $500,000 in 2009 (back when property values were low). Since then, he’s paid his principal down to $200,000, and the current market value of his home is $900,000.

Realizing that he has $700,000 in equity, minus capital gains and closing costs, Daryl finds a real estate investor interested in a sale-leaseback transaction. After the sale, Daryl receives $650,000 in equity, makes rental payments instead of mortgage payments, and quits his job for good.

When and Why Would You Want a Sale-Leaseback?

There are plenty of reasons someone may want to enter into a sale-leaseback agreement. Here are the most common ones:

• Early retirement: Being a property owner is great, but if you want to retire early, selling your home can give you access to the equity you need if you want to retire early.
• Financial setbacks: Life happens. You may get fired or laid off, have to close your business or have to cover the cost of unforeseen medical expenses. The extra cash in hand can give you the cash flow and flexibility you need to get by.
• New opportunities: The equity from the sale price of your home can be used to start a new business, make an investment, cover education costs, and more.
• Interim housing: While most lessee/lessor agreements are long-term and come with renewal options, you can also get into a short-term sale-leaseback agreement with a potential homebuyer if you’re trying to sell your home and quickly buy a new one.
• Fair rates: Many sale-leaseback agreements are long-term, meaning you can lock in the current market rate for rent. You can also sign an agreement with the buyer/lessor that includes a fixed percentage of rent increase much less than the 11.3% it rose on average in 2021.

The Drawbacks of a Sale-Leaseback Transaction

While a sale-leaseback lets you recoup your equity, frees up your finances, and enables you to stay in your home after selling it, there are some cons to the idea:

• Operating lease terms: Your lease isn’t indefinite. At the end of the lease, you either have to negotiate a new lease, repurchase the property at its current market value, or move.
• Tax benefits cease: Homeownership comes with numerous tax benefits. You no longer reap the benefits if you’re no longer the owner.
• Capital gains: As previously mentioned, you have to pay capital gains taxes on your realized gains. Typically, this is 15% or 20%, depending on your income.
• Loss of a real estate asset: You’re no longer a homeowner. Instead, you’re now renting the home you used to own.
• Renter limitations: Now that you’re renting, you may be limited on what you can do with your house, like kitchen and bathroom renovations or even painting the walls.

Sale-Leasebacks vs. Reverse Mortgages

Unlike sale-leasebacks, reverse mortgages are loans with limitations and recurring costs. Typically, borrowers end up paying origination fees, mortgage insurance, monthly interest payments, property taxes, homeowners insurance, and more. Also, you’re only unlocking between 40% and 60% of your home’s equity, as opposed to sale-leasebacks, which give you 100%. Finally, you must be at least 62 to qualify for a reverse mortgage.

Other Home Equity Options

There are other ways to access your equity without selling your home. Here’s how:

Home Equity Loan or Home Equity Line of Credit (HELOC)

Home equity loans act as a second mortgage and provide you with a lump sum based on your house’s value.

HELOCs are very similar but have slightly different terms and work like a line of credit.

To quality for either one, you need to have the following:

• At least 15% equity
• A credit score in the mid-600s or higher, preferably over 720
• A debt-to-income ratio less than 43%, preferably under 36%
• Verifiable income and employment

Cash-Out Refinancing

Some lenders will let you do a cash-out refinance and give you the cash difference between your new refinanced loan and your previous mortgage balance.

To qualify, you need to have:

• At least 20% equity in your home
• A credit score of 620 or higher
• A debt-to-income ratio of less than 43%
• Verifiable income and employment

Unlike sale-leasebacks, all these options require you to pay back money, usually at a higher interest rate than your current mortgage. However, they all let you maintain ownership of your home. The decision you make depends on your needs and what you want to do with the extra money.

Selling Your Home With Aalto

At Aalto, we’re here to help you make informed real estate decisions. We’re a self-service real estate platform dedicated to shifting the balance of power in residential real estate away from industry insiders and toward consumers.

Whether you’re looking to sell your home and continue living in it, trying to figure out what to disclose, or simply weighing your options, our goal is to make selling your home a smoother, less stressful experience.

Are you ready to take control of the homeselling process? Get started today!