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May 2010

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From Site Selection magazine, May 2010

Opportunities for Sale/Leasebacks
in Today’s Market

Executive Vice President, Corporate Finance, Grubb & Ellis Company

sset monetization, particularly via sale/leasebacks, is an established means by which companies liberate capital locked up in real estate in exchange for lease obligations. Specific objectives behind a business's decision to pursue a sale/leaseback are numerous, and can vary from company to company.Among the most frequent reasons are that such a move:

  • Improves financial performance
  • Transfers obsolescence and residual risk of ownership
  • Maintains long-term control of property as needed
  • Unlocks illiquid capital for growth and operations
  • Raises capital via non-traditional sources
  • Accesses favorable cost of long-term financing.

The primary reason companies have considered sale/leasebacks during the past few years has been to access capital at favorable rates. Let's consider the reasons behind this objective and how things have changed since the credit crisis began.

The September 2008 collapse of Lehman Brothers sent shock waves around the world and put our global financial system at risk. Initially, disruptions in global capital markets and illiquidity in the credit markets caused companies to hoard cash while searching for alternative strategies to support corporate finance needs. Today's corporate finance market has dramatically improved in some respects; in other areas, credit is still limited for businesses needing it most.

Corporate access to credit today is a tale of two worlds: strong credit or larger companies in one world, and smaller, weaker companies in another. Strong companies have easy access to cheap, abundant credit. The corporate bond market re-opened early in 2009, and by the end of the year, issuance was near record levels, with spreads for investment grade companies falling below levels prior to Lehman's collapse. By mid-year 2009, larger non-investment grade businesses were also issuing debt in the bond market. More recently, the leveraged loan market has become hot, benefiting higher-risk companies. Issuance of leveraged loans was $120 billion for first quarter of 2010, up 56 percent from the same period in 2009.

Many of these same companies hunkered down for the economic storm, hoarding record levels of cash as they slashed costs and cut capital expenditures. The result is that many investment grade and larger non-investment grade businesses have strong balance sheets with all of the cash and credit they need. The main problem these companies have is finding areas in which to invest their capital.

Not every company is strong enough or large enough to access the bond or leverage loan market, so some instead rely on banks as their primary source of credit. Banks continue to ration credit as they struggle with borrower defaults and work to strengthen their own balance sheets, even though they are in better financial shape today than a year ago. As a result, smaller and financially weaker companies find that obtaining credit is only slightly better today than this time last year. This will be a growing concern as the economy improves and business investments need to be made to meet market opportunities.

Multitude of Investors

So, when and why do sale/leasebacks make sense in this environment? Stronger companies continue to search for ways to improve their bottom line, with few opportunities to expand top line revenues. Expenses large and small receive close scrutiny, and real estate is a big expense for most businesses.

The current turmoil in real estate markets means the reverse of a sale/leaseback may make sense for some strong companies. In this scenario a business might use its cash or credit to purchase a core asset at a discounted price to drive down its real estate occupancy costs. A sale/leaseback could be executed at a future date to provide an exit strategy for the capital and/or credit required for the acquisition. Pending changes to lease accounting by the Financial Accounting Standards Board may add further motivation to pursue this strategy, as the proposed changes will eliminate operating leases and put lease obligations on the corporate balance sheet.

The benefits supporting sale/leasebacks for smaller or weaker companies are even more compelling today. A sale/leaseback can offer many advantages as an alternative source of capital, especially while bank credit remains tight. Real estate financing is not immune from the credit crisis, but the impact is not as direct or as significant as it is for many smaller or weaker businesses. Real estate investors and their lenders are new sources of financing and typically don't require restrictive covenants found in most corporate debt instruments. Access to these new capital sources via a sale/leaseback can be an effective solution for funding operations for these companies where alternatives are currently limited.

Sale/leasebacks can offer attractive pricing from new sources of capital for both strong and weaker credit companies. Today's investment market offers rates that are at or near historic lows and, with inflation looming, locking into long-term capital is a sound strategy for most any business. The cost of capital in a sale/leaseback, typically expressed as a cap rate, is often favorable compared to other corporate finance instruments of matching maturities when the full costs are considered. Corporate borrowing requires full repayment of principal, whereas 25- or 30-year amortization schedules for mortgage debt often used in sale/leasebacks provide positive leverage in pricing, since only a portion of the debt is paid down during the primary term of lease.

Now can be a good time to convert illiquid real estate assets into cash via a sale/leaseback. There are a multitude of investors for corporate assets under sale/leasebacks, despite the current disruption in the world of real estate investment and finance. Private and institutional investors — both foreign and domestic — view U.S. real estate as a preferred asset class, especially investments offering the stability and security of fully leased properties to sound corporate occupiers. Real estate provides investors with excellent risk-adjusted returns and offers a natural hedge against inflation. There is currently little quality product on the market and high investor demand, so now might be a great time to consider a sale/leaseback for many businesses.

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