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ome on down and do a sale-leaseback right now. Get a high price; pay a low rent. Hurry. This is a limited time offer.
For the past year or so, investors across the board have been re-evaluating their commitments to the stock and bond markets, sizing up alternative investments, and pumping money into real estate. Sale-leaseback companies structured to buy properties with cash raised through funds supported by investors have benefited from this new investment capital.
For example, New York-based W. P. Carey & Co. LLC has been on a tear. During 2002, the company’s current fund completed more than $1 billion in transactions with 25 companies, compared with a total of $395 million for 20 transactions in 2001.
Historically, W. P. Carey has carried out non-investment grade sale-leaseback transactions with solid companies. The influx of cash has led the company to expand its criteria to include investment grade transactions as well as overseas transactions.
By December of 2002, Wells Real Estate Funds of Atlanta had acquired 26 properties in deals totaling $1.1 billion and had another $300 million in deals pending. Those numbers compare to transactions valued at $245 million in 2001.
Both companies attribute their buying capabilities to tremendous flows of capital into their real estate investment funds.
High real estate returns relative to the stock and bond markets are also fueling sale-leaseback start-ups. One of those new companies, Levitt Realty and Finance of Ft. Lauderdale, cranked up in September of last year. Owned by BankAtlantic Bancorp, also of Ft. Lauderdale, Levitt hopes to carry out $50 million to $100 million in sale-leaseback transactions this year.
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Not all sale-leaseback providers stormed the market last year. Corporate Partners Capital Group, Inc., in Los Angeles reports doing more selling than buying in 2002. According to principal Kent Wright, the company pursues sale-leasebacks with investment grade, sub-investment grade, and cusp investment grade corporations. Last year, many of these companies chose to finance real estate by borrowing funds. But that seems to be changing. “Companies don’t have the same access to capital as last year, and we think our activity will pick up this year as a result,” says Wright.
Corporate Partners Capital plans to invest $300 million in sale-leasebacks this year. The company is particularly interested in the sale-leaseback possibilities offered by the increased merger and acquisition activity characteristic of slow economic times. “We’re seeing a trend with private equity shops looking at sale-leasebacks to help finance acquisitions,” Wright says. “Right now we’re talking to companies about three possible transactions that total $1 billion.”
One transaction involves the acquisition of a restaurant chain. “The company has a significant number of restaurant units, and they want to use sale-leaseback financing to help capitalize the acquiring company,” says Wright.
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Despite all this activity, sale-leaseback providers are chasing a limited supply of properties. According to Bruce MacDonald, president of Net Lease Capital Advisors, the annual creation of sale-leasebacks remains fairly steady from year to year. “The range is $5 billion to $7 billion,” he says. “The highest number I’ve ever heard is $10 billion, but I don’t think anyone in the business believes that.”
Properties held by investment grade corporations make up the most attractive subset of the sale-leaseback market. Dubbed the credit-tenant-lease or CTL market by sale-leaseback providers, this market is small. According to MacDonald, the CTL universe has held steady for years at $2.5 billion. Every year, about $1.5 billion flows out of the market into the hands of investors interested in long-term ownership. Another $1.5 billion flows into the market as investment grade corporations sell and lease back to companies interested in re-marketing these properties.
As more and more new cash moves into the relatively stable universe of sale-leaseback properties, prices have nowhere to go but up. For the time being, investors continue to pay well for real estate assets, especially those controlled by long-term leases to credit-worthy corporations. “We would like to see more of those kinds of properties,” says Andrew Kraus, managing director with Cornerstone Capital Corporation of Dublin, Ohio, a lender and sale-leaseback provider. “Investors really want them.”
Indeed, corporations with investment grade credit ratings can find excellent and flexible sale-leaseback deals. As the market bids up real estate prices, owners can demand higher prices for their buildings and extract maximum cash value. Then again, owners might sell at a lower price, and extract value in the form of both cash and lower rent.
Unfortunately for sale-leaseback providers eyeing this market, investment grade corporate property owners don’t need sale-leaseback cash. Limited availability of capital creates conditions that enable sale-leaseback providers to flourish, and that isn’t the case today.
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“Corporations have built up tremendous supplies of cash,” says Tom Dujanovic, president of Levitt Realty and Finance. “For example, Cisco Systems has over $20 billion in cash. Now I’m a good salesman, but how can I ask a company like Cisco if they want more money?”
Investment grade corporations also have access to cash through credit lines priced at historically low interest rates. “Today, a major corporation can borrow money at less than 3 percent,” Dujanovic continues.
So new money and low interest rates are bidding prices up and lowering capitalization rates or yields. Still, sale-leaseback providers are willing to accept lower yields. Even at 6.5 percent or 7 percent, real estate continues to outpace the stock and bond markets.
Sooner or later, however, other economic realities will have to kick in — won’t they?
Cornerstone’s Kraus, for example, notes a growing disconnect between real estate fundamentals and real estate prices in the real estate markets, as rents soften and vacancies rise. Unless the general economy moves into a stronger recovery mode, declining rents and rising vacancies will eventually cut real estate returns on properties with already low cap rates.
Sale-leaseback providers generally insulate themselves against these problems with long-term leases. According to some observers, however, the urge to buy real estate today is so strong that some sale-leaseback companies have strayed from long-term leases.
“Financing a sale-leaseback property for 25 years with a 15 year lease is risky,” says Dujanovic. “People are doing this today. Worse, some people are financing properties with 15-year leases by using 25-year amortizations and 15-year calls. What happens 15 years from now if the building isn’t worth what you paid for it?”
One way or another, overpaying for real estate will eventually have economic consequences. “There are people paying prices in this market that have never been seen before and may never be seen again,” says Michael Dorsch, executive vice president with iStar Financial, Inc., in Miami. “We’ve been reluctant to buy at those prices, and we’ve passed on a number of transactions.”
Even so, in a seller’s market, you pay the seller’s price. In the fourth quarter of last year, for example, iStar bought a 460,000- sq.-ft. (42,734-sq.-m.) suburban east coast office building at a cap rate so low Dorsch can’t bear to mention it. “It was the lowest cap rate we’ve ever bid on and the lowest I’ve ever bought in my career,” he says.
Three saving graces made the deal work: the quality of the tenant, the building, and the lease. “We got a strong investment grade tenant in a first class building with a 20-year lease,” Dorsch says. “And the return is higher compared to what you would get if you bought the company’s bonds directly. Ultimately, that’s the gauge.
“With a bond, you get your money back at the end of the term,” he continues. “So you also have to think about how you’ll get your money back on a sale-leaseback. That comes from the residual value of the property. If we didn’t believe that we could sell this building for what we paid at the end of 20 years, we would have had to adjust the cap rate up.”
How long will sale-leaseback providers continue to pay these kinds of prices? Until long-term interest rates rise by a full percentage point, says Dujanovic.
“At that point, the advantage will move, at least a little, from sellers to buyers,” he says.
Until then, come on down. Get some sale-leaseback cash and low, low rent.
Continue to sidebar: Synthetic Leases Vs. Sale-Leasebacks