From Site Selection magazine, May 2012
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Still a Viable Strategy
s the economic recovery continues, sale-leaseback remains an effective capital-raising solution in a capital-constrained environment for operating companies that own commercial real estate properties. This financial vehicle allows a company to access otherwise illiquid capital that is tied up in its real estate and redeploy the capital to achieve higher returns, typically into the company's core business. And there is strong demand by investors and institutions for corporate leased real estate assets.
How It Works
In a typical sale-leaseback transaction an owner sells its owner-occupied building(s) to an investor in exchange for a lease commitment (usually long-term) by the owner. The transaction frees up capital for use in business operations and for financing growth. Advantages to the owner include:
- Non-liquid assets are converted into cash.
- Receipt of full market value for real estate assets.
- Capital assets are removed from the balance sheet and replaced by cash.
- Debt equity ratios are improved.
- The lease payments are tax deductible to the new tenant (former owner).
Sale-leasebacks may also be used for new development. The transaction can be negotiated with simultaneous lease commencement, business opening, and sale closing.
The owner can enhance the value of the asset by structuring a lease with a longer lease term (say 10 to 20 years), a market lease rate with annual or periodic rate escalations, assuming all operating expenses of the facility (NNN lease), and possibly all capital expenses (including roof and building structure).
Strong Investor Demand
Sale-leaseback properties are very much in demand by investors seeking long-term stable and predictable bond-type returns. The quality of the real estate, the tenant, rent increases, and lease term all add to the value of the investment. Advantages to the investor include:
- Predictable long-term stream of cash flow.
- Low management required for the investment.
- The value of the property can appreciate, approximately at the rate of the lease increases.
- The annual increases in the rent rate, along with the possibility of appreciation, are a hedge against inflation.
- The property provides some tax shelter through depreciation and other write-offs.
- Positive leverage is typically possible to enhance the return.
- Disposition potential with sufficient remaining lease term.
"There is tremendous pent-up demand that we are seeing get released as low return cash is chasing too few good real estate assets," said Mark Fornes, founder of Dayton, Ohio-based Mark Fornes Realty. "With decent credit and some length of lease remaining, it's a great time for sale-leasebacks." Michael Chase, senior vice president of Stag Industrial, a single-tenant industrial REIT, echoes that view.
One of the top investors in long term net-leased single-tenant properties, Phoenix-based Cole Real Estate Investments has acquired portfolios of retail properties leased to high-quality creditworthy tenants. Cole's $1.1 billion in retail acquisitions last year included $387 million in sale-leasebacks. The company also invests in office and industrial assets, including the 600,000-sq.-ft. University of Phoenix office complex it acquired in a $170-million sale-leaseback transaction, one of the largest single-tenant office transactions in Arizona history.
According to Real Capital Analytics, U.S. sale-leaseback transactions reached a peak of $16 billion in 2007 and dropped to a low of $3.73 billion in 2009. Transaction volume has increased beginning in 2010, increasing to $5.3 billion last year.
Cap rates vary by property type, location and tenant credit, with CBD office as the highest valued. All cap rates are compressing now.
Sale-leaseback can be used for nearly any property type. Typical examples are long-term NNN single-tenant leases for retail properties: drug stores, chain restaurants, supermarkets and other national or regional retailers. Bank branches, which are located on retail sites, often outparcels of shopping centers, are another popular use.
"We are seeing significant sale-leaseback activity by banks," said John Tomlinson, Wells Fargo Bank senior vice president and Central Florida manager.
A few of the current opportunities marketed to investors include NNN single-tenant CVS, Walgreens, McDonald's, Sherwin Williams, a Chevron gas station, national brand fitness centers, big-box retailers, bank branches, and in the medical field, dialysis centers operated by Fresenius and DaVita. NAI Global Investment Services Group is marketing a Siemens single-tenant office building in Dallas, and an AT&T operations center is available in Reno, Nev. Government credit facilities on the market include a new GSA Social Security Administration office building in Michigan and a K-5 urban school in Stockton, Calif.
On the industrial side, Pennsylvania-based Seagis Property Group LP bases its investment decisions on consistent underwriting criteria and considers sale-leaseback alongside its other investment strategies, focusing on logistically driven warehouse markets along the Eastern Seaboard. "Location and good product are key," said Laurie Brown, Seagis senior vice president.
"The key is the viability of the tenant's business and that it is not a special purpose building," said Stanley Alterman, executive managing director of USAA Real Estate Company. Investors consider reuse potential of a building in the event it becomes necessary to re-tenant the space. "The more generic the building, the better," Alterman said.
New FASB-IASB Lease Accounting Standards
The FASB and IASB have been jointly developing the proposed lease accounting rule changes. While the changes have not yet been finalized or implemented, it is clear that off-balance sheet treatment will be eliminated. Under the new rule all leases will be required to be included in a company's balance sheet.
The impact of the new rule is not known at this time. John Herbert, investment banker and managing director of Florida-based 6/10 Capital Advisors, believes there will continue to be strong investor demand for traditional sale-leaseback deals, especially for middle market companies that do not have the investment-grade rating required for insurance company private placements, but still considered acceptable risk.
Select members of the NAIOP Research Foundation, Industry Trends Committee, and Industrial Development Forum I contributed to this article.
George Livingston, CIPS – Chairman, NAI Realvest and CommerCenters; Christie Alexander – Principal, NAI Realvest, Orlando, Fla.