– With an estimated US$8.0 trillion of corporate-owned real estate throughout Europe and with transactions involving Amazon, Bertelsmann’s, Commerzbank, Deutsche Telekom, DHL, Goldman Sachs, Zara, real estate sale-leaseback is on the onset of becoming the alternative financing tool of choice for corporates.
– Applicable across all industry sectors and real estate types, European corporates use sale-leaseback as a tool to grow, finance and refinance, optimise their balance sheet, or reduce their cost of capital.
– Customised structuring, long-term flexibility and certainty of closing appeal to the needs of corporate management reviewing their real estate strategies to effectively monetise their illiquid assets and streamline their operations.
A Mature Industry In The US
Rooting back to the 1980s, sale-leaseback developed in the US into one of the 12 sub-sectors of the real estate industry with an estimated annual transaction volume of US$70 billion.
The industry offers mature and transparent characteristics with established institutional investors solely focusing on net lease transactions (commonly referred to as “real estate sale-leaseback”).
Today, private REITs, public REITs and private equity closed-end funds with a net lease strategy are concentrating on both traditional real estate such as corporate offices, logistics warehouses and retail units, but also on niche assets such as R&D centres, manufacturing plants, car dealerships, petrol stations, recycling plants, universities or schools, and cinemas, to name a few.
The European Evolution
After the 2008 Global Financial Crisis, when traditional equity sources, bank financing and capital market funding dried up, sale-leaseback emerged amidst the rise of private debt and non-bank financing.
Whereas the common perception among many European corporates relates the term “sale-leaseback” predominantly to production equipment and machinery, the idea of unlocking tied-up (or idle) capital through sale-leaseback of corporate real estate was relatively new.
When traditional commercial real estate investors would rather concentrate investment strategies on corporate offices and light industrial premises, only a handful dedicated investors would follow a “product and industry-agnostic” strategy by investing into “tenant-specific assets” to play to the specific needs of corporates. And, hardly any of those investors were of pure European origin.
With an estimated US$8.0 trillion of corporate-owned real estate in Europe and with only a few fully-dedicated investors present on the ground who invest in “operationally” or “mission-critical” corporate real estate, the European economic landscape is offering sound business opportunities for both corporates and investors.
Commonly Used By Multi-Nationals & Legit For Middle-Market Corporates
Merging the disciplines of private credit, corporate finance and real estate, sale-leaseback is offering an array of application fields, customised structuring and flexibility.
With a growing number of European companies reviewing their corporate real estate strategy and weighing options for alternative long-term and multi-purpose financing, real estate sale-leaseback is clearly on the rise throughout Europe: transactions involving the likes of Amazon, Bertelsmann’s, Commerzbank, Deutsche Telekom, DHL, Goldman Sachs, Zara foster the perception of sale-leaseback as an appropriate alternative financing tool for European corporates of all sizes and across industries. This holds true and is reinforced even more in a post-COVID landscape.
The Essence Of Sale-Leaseback
The essence of sale-leaseback is the purchase-and-sale agreement between a corporate real estate owner and an investor, with the investor (buyer) simultaneously leasing back the property to the corporate seller on a long-term basis whereby lease terms span from 10 to 30 years.
Sale-leaseback structures are applicable across nearly all industry sectors and pertain to all commercial and industrial owner-occupied real estate types including offices, logistics warehouses and retail units, but also on niche assets such as R&D centres, manufacturing plants, car dealerships, petrol stations, recycling plants, universities or schools, and cinemas, among others.
The Investor Perspective
From an investor (i.e. buyer) perspective, sale-leaseback is perceived as an attractive investment proposition, comparable to a long-term fixed income/bond type investment.
Institutional fixed-income investors may increase their exposure to real estate via an investment product with a corporate tenant already in place generating a long-term return, driven by predictable annuities rather than capital appreciation.
Given the present low-yield income environment, the exposure to sale-leaseback particularly plays to the needs of pension funds looking for stable yield when allocating their resources among specialised fund managers.
The Corporate Perspective
Reinvesting Into The Core Business
From the corporate perspective, the nature of a sale-leaseback transaction is widely considered as an alternative financing tool by unlocking tied-up value through the sale of corporate real estate.
By making the move from “owning” real estate to “operating” real estate in exchange for a long-term lease contract, corporates can reduce their exposure to non-core assets, and focus on their core business without bearing the risks of owning a property.
They can convert a depreciable asset into cash to feed different purposes, from reinvesting the sale proceeds into growth measures, like financing acquisitions, refinancing or paying-off bank facilities, facilitating buy-outs, to the optimisation of balance sheets and to the reduction of cost of capital.
Different structuring possibilities, including potential buy-back options and substitution rights, add to the flexible nature of sale-leaseback agreements.
Fields Of Application
In the aftermath of the 2008 financial crisis, access to financing remained tight, with middle-market companies facing new cost challenges amidst the rise of mezzanine and unitranche products which were then offered by a new breed of non-bank lenders. The latter came with an increase in costs, additional PIK (Paid-in-Kind) structures and terms generally not longer than 7 years.
With the surge of sale-leaseback, private and listed corporates, as well as private-equity owned companies, found various incentives to monetise their real estate assets and reinvest capital into core business operations.
M&A & Growth
When acquiring new companies, sale-leaseback can be utilised to finance or refinance part of the acquisition by selling the property in a long-term leaseback structure.
With flexible lease terms and buyback options in place, corporates keep full operational control of their assets while improving profitability ratios such as “return on capital employed” (ROCE) and “return on assets” (ROA).
When bank facilities expire, sale-leaseback offers a viable option to refinance or to replace both senior and subordinated tranches (including mezzanine) within the capital stack.
Sale-leaseback provides attractive cost structures while concurrently improving bank and/or capital market ratings at terms rarely provided by traditional lending sources.
While the duration of the average conventional debt-financing could go up to 10 years, sale-leaseback agreements span from 10 to 30 years, thus providing for considerable flexibility and offering the possibility to fix operating costs for the long-term. Whereas bank financing may focus on the “third-party usability” of real estate, sale-leaseback can be structured for “hard-to finance” assets as well, regardless of property type, use or location.
Unlike conventional corporate financing, sale-leaseback hardly comes with financial covenants (e.g. debt-service-coverage ratios, monthly reporting, cash-sweep covenants, etc.), allowing corporate management to use the proceeds from the property sale at full discretion while keeping operational control over the assets.
Pricing & Efficient Monetisation Of Illiquid Assets
Sale-leaseback agreements are situated between senior and mezzanine financing and are measured by the cap rate at which the investor acquires the asset.
This to-be-agreed-upon cap rate is typically set by adding an illiquidity premium to a company’s cost of long-term financing. In contrast to bank or mortgage financing with LTVs and LTCs of typically 35-65% of a property’s appraised value, a sale-leaseback monetises 100% of the appraised value of the underlying real estate.
At first glance, sale-leaseback may seem more expensive than the average senior financing but is not amortised (i.e. it is comparable to an “interest-only” loan) and management must compare it with its own cost of debt and equity, and take into account bank and investor financing terms, as well as the importance of security in long-term planning, flexibility, and certainty of closing.
Consolidating Ownership / Buy-Out
When corporates consider buy-outs of shareholders to consolidate ownership, sale-leaseback may be a solution of choice while keeping full operational control of the company – in contrast to the sale of parts of the business to external financial investors.
When expansion strategies call for the construction of new customised sites (e.g. warehouses, production facilities), which are rarely available “off-the-shelf” on the real estate market, a build-to-suit financing agreement could provide certainty of completion and a considerable reduction of planning risk: in exchange for a long-term lease agreement, the investor would directly acquire the asset from the developer or the corporate owner at pre-agreed terms and upon completion and after receiving certificates of occupancy. That also enables the corporate user to finance its expansion without using its operational cash flows.
The Underwriting Process –
The Role Of The Tenant’s Credit
The character of a sale-leaseback transaction is aimed at a long-term future partnership and typically calls for 45 to 60 days needed until the conclusion of final agreements.
Besides the negotiation of the purchase & sale and lease agreements, a robust due diligence reviews both the real estate (valuations, trading/lease comparables, take-up rates, demographics, go-dark scenarios, environmental aspects), and the future tenant’s credit strength (i.e. looking at the same fundamentals and ratios as in corporate acquisitions).
Both aspects affect the cap rate and the lease length, whereby the quality of the real estate and the tenant’s credit may offset each other, i.e. high quality and operationally-critical real estate assets may make-up for an inferior tenant’s credit (and vice versa).
Boosted by recent prominent transactions like the Bertelmann’s headquarters in Munich, sale-leaseback has become a compelling alternative for European corporates when reviewing their real estate strategy to effectively monetise their illiquid assets and to streamline their operations.
As the European sale-leaseback marketplace consists of only a handful of dedicated investors, corporates may choose the right partner by taking into account its track record, sector experience, understanding of the European corporate culture, investment flexibility and availability for add-on business.