Commercial Real Estate
Three Strategic Uses of Sale-leaseback Capital for CFOs
There are several reasons businesses of all sizes may choose to monetize their owned real estate through a sale-leaseback. A sale-leaseback is an effective financing tool to unlock seemingly illiquid capital that can be reinvested into a company’s core business to fund both internal and external growth. It can be a particularly useful tool when traditional debt financing is difficult to secure or available at less attractive terms. Another key benefit is that the proceeds from a sale-leaseback can be used for essentially anything – from improving a company’s cost of capital to paying off debt. This flexibility enables CFOs to allocate sale-leaseback proceeds to the areas where their business needs it most at any given time. In today’s economic environment, CFOs can strategically leverage sale-leaseback capital to address several of the biggest concerns – and opportunities – that businesses are currently facing, including M&A, inflation and capital raising. Here’s how: Finance M&A In an M&A market that remains highly competitive, sale-leasebacks can be a useful tool to give companies an edge against their peers. Sale-leasebacks are an attractive means to finance M&A by enabling companies to take advantage of the value arbitrage between their real estate valuation and EBITDA multiple. When completing a sale-leaseback concurrently with an acquisition, the proceeds can effectively “buy down” the acquisition multiple and boost returns. In addition, leveraging sale-leaseback capital enables companies to avoid many traditional debt challenges like refinancing risk and balloon payments. By pursuing a sale-leaseback now, companies can also lock in an attractive rental rate for the long-term while cap rates remain low and before interest rates rise significantly. Counteract Inflation Inflation continues to surge at its fastest pace in 40 years. In April, the Consumer Price Index continued its upward trajectory, increasing 8.3% from one year ago. While the Fed has made some efforts to fight inflation, there is still a lot to be done to get prices down to more normal and stable levels. This is bad news for businesses, who are dealing with dwindling cash flows as costs continue to rise for raw materials, manufacturing and overhead. However, savvy CFOs can leverage sale-leaseback capital to help fund initiatives to mitigate the negative impacts of sustained high inflation. Sale-leaseback capital can be invested into automation equipment, new production lines or other areas with return on capital in excess of cap rates to increase production line efficiency and maintain operating margins despite increased pressure on costs. Unlock Illiquid Capital to Fund Internal Business Growth In today’s more volatile environment, having access to capital is critical to not only expanding externally through M&A, but also to investing in existing business lines. By pursuing a sale-leaseback, CFOs can unlock liquidity on a business’s balance sheet and reinvest those proceeds back into the core business, all while maintaining long-term occupancy and operational control of the real estate. Companies can launch new products, acquire additional equipment, fund R&D and grow their market share in existing business lines. This organic growth can in turn help attract top talent, particularly in the current tight labor market.
What to Know When Leveraging Sale-leasebacks to Finance M&A
The global M&A market experienced record activity in 2021, topping $5 trillion for the first time as unprecedented dry powder, a low cost of capital and demand for inorganic growth fueled dealmaking. Savvy corporate acquirers and private equity investors looking to jump in on the action have seized the opportunity to use creative financing options that unlock equity, strengthen balance sheets and free up capital for strategic initiatives and additional transactions. Enter stage right, the sale-leaseback. In 2021, sale-leaseback volume topped $24 billion, up from nearly $13 billion in 2020. For those interested in joining the growing number of investors and acquirers leveraging sale-leaseback financing alternatives to supplement M&A activity, here’s what you need to know. How do you know if a sale-leaseback should be part of an M&A transaction? There are a couple of key considerations in determining whether to pursue a sale-leaseback as part of an M&A strategy. First, identifying whether or not owned real estate is critical to the pro forma business in the long run. A sale-leaseback is a long-term source of financing, so it’s important that the real estate involved is not only critical to the pro forma entity’s operations, but that the company is comfortable with committing to a meaningful lease term. Just as important is understanding the market’s appetite for the specific real estate and rent cash flow in contrast to the entity’s cost of capital. Tenant credit, facility criticality and quality of the real estate are all factors that contribute to how competitive a sale-leaseback strategy might be against more traditional financing strategies in supporting a transaction. How do the current inflation levels and the Fed’s rate hike impact M&A volume and attractiveness of sale-leasebacks? There are certainly some headwinds, with rising rates, the expected tightening of regulation and potential for changes in tax policy all driving a “wait and see” approach for some acquirers. However, activity so far in 2022 is still visible and the recent rate hikes and overall volatility in the debt capital markets make alternatives to traditional debt financing, such as sale-leasebacks, an even more attractive option in funding M&A strategies. What are the advantages of sale-leasebacks compared to more traditional routes of financing? There are quite a few advantages to financing via a sale-leaseback: the avoidance of many traditional debt challenges such as a balloon payment or need to refinance at the end of the term, and in some cases, less stringent financial covenants. In addition, many companies also benefit from the flexibility of extension options and operating lease treatment, all without immediately forgoing control of critical real estate or disrupting day-to-day operations. Depending on the buyer, sellers may also gain a long-term capital partner who can work with them far into the future to ensure their real estate continues to meet their evolving business needs. It’s also important to remember the cost of capital for a real estate investor is often extremely competitive. In some cases, this—coupled with the fact that a real estate investor is better suited for property ownership as it aligns with its core competency—means a real estate investor will buy assets at a higher multiple compared to an M&A target’s valuation, thereby unlocking a value creation opportunity that benefits from the combined operating business and real estate value. In addition, some companies find that by converting illiquid real estate assets into liquid capital at a favorable cost, the pro forma company is able to optimize its cost of capital. Conclusion With optimism that M&A activity will remain strong despite the current market headwinds, I anticipate sale-leaseback activity will continue to soar in 2022, particularly as awareness of this valuable financing strategy among private equity investors and corporate owner-occupiers becomes more prevalent. When working with an experienced real estate investor, sale-leasebacks can be a powerful and reliable tool to finance acquisitions and fuel corporate growth.
The Institutionalization of Net Lease
The net lease market has become a hunting ground for investors looking for low-maintenance assets and long-term, predictable cash flows. The stability of the asset type during times of uncertainty has attracted attention from new investors – with the net lease share of all commercial real estate investment activity rising 14.7% in 2020. While it has historically not been viewed as one of the major food groups in commercial investments, this perception is changing as more capital continues to flow into the market. What's driving new capital? There are several factors that have contributed to the influx of capital in the net lease space, but the biggest factor is the appeal of long-term stability. With reliable cash flows, triple-net structures and generally longer lease terms, net lease investments are far less volatile than other assets and create predictability in a portfolio. While there was wide discrepancy across the net lease sector during COVID, generally net lease portfolios – particularly industrial and those focused on critical real estate – performed extremely well and delivered high rent collections when compared to other asset types. In addition, recent inflation fears have driven investors toward traditionally inflation-resistant asset classes like real estate, and net lease in particular has been popular in that context. What types of institutions have shown the most interest in the sector? There are several factors that have contributed to the influx of capital in the net lease space, but the biggest factor is the appeal of long-term stability. With reliable cash flows, triple-net structures and generally longer lease terms, net lease investments are far less volatile than other assets and create predictability in a portfolio. While there was wide discrepancy across the net lease sector during COVID, generally net lease portfolios – particularly industrial and those focused on critical real estate – performed extremely well and delivered high rent collections when compared to other asset types. In addition, recent inflation fears have driven investors toward traditionally inflation-resistant asset classes like real estate, and net lease in particular has been popular in that context. What does this mean for corporate sellers? Now remains a great time for corporate sellers to monetize real estate. High investor interest and limited supply is driving cap rates down and prices up, meaning sellers can maximize the value of their assets if they pursue a sale-leaseback now. Supply chain issues have highlighted the importance of industrial properties in particular, resulting in further price appreciation for industrial owners. Since there is an expectation that interest rates will rise next year in response to inflation, corporate owners should take advantage of the sellers’ market and pursue a sale-leaseback sooner rather than later to lock in today’s low rates on a long-term basis. Conclusion Although new entrants entering the net lease space are forcing cap rates down, the overall impact on the market is a net positive. Greater investor interest is also driving down cost of capital accordingly, meaning investors can still accretively do deals at lower cap rates since debt is relatively cheap. In addition, increased visibility of the net lease market lends credence to the asset class as a whole and creates more awareness for net lease and sale-leasebacks among corporate sellers – driving overall deal volume higher. From W. P. Carey’s perspective, 2021 has been a record year for deal volume and we have been able to support many companies in unlocking the value of their real estate and redeploying those proceeds into their core businesses…So bring on the competition!
How Sellers Can Maximize Value During Times of Inflation
Driven by the economy reopening and increasing consumer demand, the US economy is experiencing the biggest surge in inflation in over a decade. The Fed expects higher-than-usual inflation to continue throughout the year, but believes it is transitory and will level off next year as supply chain bottlenecks caused by the pandemic resolve. Although inflation is often associated with negative factors such as higher prices for consumer goods and higher labor costs, corporate owner-occupiers can benefit from a surge in demand for hard assets through a sale-leaseback of their corporate real estate. In a sale-leaseback, a company sells its real estate to an investor for cash and simultaneously enters into a long-term lease. The seller works with the buyer to structure a lease for a period that meets its needs without having to worry about refinancing. The seller can then use the cash to grow its business, reduce debt or execute on other higher-return core business initiatives. While there are numerous reasons to leverage this cost-effective financing tool in all market conditions, there are added benefits for sellers amid rising inflation: Increased property values: During inflationary periods there is higher demand for hard assets such as commercial real estate, as it is a natural inflation hedge due to its appreciation over time. This means that more buyers are in the market, increasing competition and driving real estate prices higher. Less supply: Inflation leads to increased material and labor costs, which disincentivizes developers from building new properties and limits supply. This puts a premium on existing, high-quality properties, which reinforces the fact that sellers can unlock more value out of their real estate. Higher borrowing costs: The cost of borrowing is typically impacted during inflationary periods, as inflation devalues the currency and forces lenders to raise interest rates. As a result, loans will be a more expensive option for companies when compared to long-term sale-leaseback financing from all-equity buyers who are better positioned in an inflationary environment. Favorable rents: Before the Fed’s anticipated hike of interest rates next year, sellers have the opportunity to lock in current low rates on a very long-term basis. The lease term on a sale-leaseback is typically anywhere from 15 to 25 years compared a five- or even 10-year term on a commercial mortgage. Sale-leasebacks also enable the seller to unlock 100% of the value of the real estate compared to a bank mortgage, where 70% to 75% loan-to-value ratio is more likely. For corporate sellers seeking working capital this means now is the time to act. When considering a sale-leaseback, it’s important to partner with an experienced, all-equity buyer with both the expertise to close quickly and the capital to support its tenants’ long-term business objectives. W. P. Carey has specialized in sale-leasebacks for nearly 50 years and prides itself on being a long-term partner to its tenants. If you or your client are interested in selling your corporate real estate, contact us today.
Sale-leaseback 101
What is a sale-leaseback? The concept is simple. For many companies, their real estate represents a significant cash value that could be redeployed to fund their core business operations and growth strategies. Through the “sale and leaseback” model (or sale-leaseback), a company sells its real estate to an investor for cash and simultaneously enters into a long-term lease with the new owner. In doing so, the seller extracts 100% of the property’s value and converts an otherwise illiquid asset into working capital, while maintaining full operational control of the facility. What are the benefits? There are many reasons why a company would consider monetizing its owned real estate. Sale-leasebacks offer companies an alternative to traditional bank financing. This is particularly advantageous during periods of uncertainty—as seen during COVID-19 when conventional financing was limited, especially for sub-investment grade companies. Whether a company is looking to invest in R&D, expand into a new market, fund an M&A transaction or simply de-lever, sale-leasebacks serve as a strategic capital allocation tool to fund both internal and external growth in all market conditions. Key benefits include: Immediate access to capital to reinvest in core business operations and growth initiatives with higher equity returns. We like to say that most businesses are not in the business of owning real estate. A sale-leaseback enables companies to focus on its core competencies, while capitalizing on the value arbitrage between the real estate valuation and the company’s EBITDA multiple. 100% market value realization of otherwise illiquid assets compared to the 65% to 75% of the appraised value that a typical mortgage would garner. Limited financial covenants, unlike some debt instruments, providing the seller with greater control over its operations. Alternative capital source when conventional financing is unavailable or limited. Retainment of operational control with no disruption to day-to-day operations. Potential tax benefits by deducting rental payments rather than being subject to interest limitations for traditional debt as defined by tax laws. Why now? Record level dry power, coupled with today’s low interest rate environment continue to drive investor demand for alternative investments such as real estate, pushing property values to all-time highs. These conditions make now an opportune time for sellers to maximize their proceeds and secure favorably priced, long-term capital via a sale-leaseback before interest rates rise again. In conclusion Key to the success of a sale-leaseback arrangement is finding an experienced and well-capitalized investor who can understand the unique requirements of each seller and structure the lease accordingly. When working with an investor like W. P. Carey, sellers have the added advantage of gaining a long-term partner who can support its tenants through long-term flexibility and additional capital should they wish to pursue follow-on projects such as expansions or energy retrofits as their business and real estate needs evolve.
What’s Behind Food Production’s Interest in Sale-leasebacks
The food production sector has been a significant source of recent deal flow for W. P. Carey – in 2020 we completed five investments in the sector totaling $210 million. In part, this is due to the overall stability of the industry. Even amid a global pandemic, food is essential, and most food companies have continued to perform well – particularly those with a diversified customer base. As a result, many food production companies are seeking capital to keep up with demand and discovering the opportunities a sale-leaseback presents – the ability to quickly unlock the capital tied up in their commercial real estate to reinvest into their core business. In a sale-leaseback, a company sells its real estate to an investor like W. P. Carey for cash and simultaneously enters into a long-term lease, while maintaining full operational control of the facility. For food production companies, a sale-leaseback can be a critical tool to increase cash flows and support long-term growth. Here’s how: Lock in low rates with a long-term lease and recapitalize balance sheet The COVID-19 pandemic forced many companies to take a hard look at their balance sheets and find opportunities to recapitalize and add working capital. For food production companies that aren’t in the business of owning real estate, those real estate assets can be a significant weight on their balance sheets. A sale-leaseback, particularly in the current low rate environment, can enable them to monetize these assets at a cost that creates a positive arbitrage, given what the capital can earn when those proceeds are invested in their core business. In October, we completed a $34 million sale-leaseback with a food production company in the Midwest where proceeds were used both to pay down debt and add working capital to the balance sheet. In addition, while interest rates currently remain at historic lows, they are expected to rise in the years to come. By pursuing a sale-leaseback and signing a long-term lease now, companies can lock in attractive rental rates for 15 to 30 years. Unlock capital to support new acquisitions and future growth Food production has remained one of the most resilient sectors during the pandemic, with some companies even benefiting from the trends that have emerged – including a greater demand for e-commerce and at-home grocery deliveries. To capitalize on these trends, food production companies are looking to shore up capital for new acquisitions that will support their future growth. Sale-leasebacks are a great method to supply companies with this dry powder, enabling them to act quickly on opportunities and take advantage of the market. Proceeds can also be used for other growth initiatives, including investments in new technology or equipment that will help increase efficiency, improve delivery capabilities and help meet growing demand. Earlier this year, we completed a $75 million sale-leaseback of two packing, production and distribution facilities in California with a leading grower-packer of seasonal, high-value summer fruit in which the proceeds were used to help fund growth initiatives for the company. Secure a long-term capital partner If companies choose the right buyer in a sale-leaseback, not only can they unlock immediate capital, but they can also secure a long-term partner to support ongoing growth and real estate needs. These can be add-on acquisitions, build-to-suits of new facilities or expansions of existing facilities. Particularly as demand for e-commerce is expected to increase, having a long-term capital partner can be a critical component to a company’s growth strategy and give them an edge against competitors. We completed several projects with our existing tenants in the food production sector last year to help support their growth. In June, we completed a $75 million build-to-suit of a brand-new, state-of-the-art food production facility in San Antonio, Texas with our existing tenant, Cuisine Solutions, the largest manufacturer of sous vide food. The facility enabled Cuisine to address growing demand and expanding operations. In addition, we completed a warehouse expansion in an accelerated timeframe in Portugal with our tenant, Sonae MC, a leading Portuguese food retailer, to help them meet rapidly growing demand as a result of the pandemic. In closing As food production companies continue to recognize post-pandemic opportunities for growth and enhanced profitability, demand for attractively priced sale-leaseback capital as a long-term source of funding will increase. The liquidity provided by a sale-leaseback can support a range of corporate initiatives, including balance sheet recapitalization, paying down debt and shoring up working capital for future growth. Thoughtful lease structuring along with timely execution are crucial factors requiring an established sale-leaseback partner with recognized experience, relationships and reputation. In addition, it’s critical to find a partner with a long-term outlook to help fund both current and future needs. At W. P. Carey, we’re a long-term investor and endeavor to support our tenants throughout the duration of their leases so they have the capital and real estate they need to remain successful. If our tenants do well, we do well – it’s a symbiotic relationship.