Commercial Real Estate
Three Ways Supply Chain Disruptions are Impacting the Commercial Real Estate Market
The emergence of the coronavirus in early 2020 caused a drastic slowdown in supply chains across the globe. Labor shortages, fluctuating consumer demand, disruptions in shipping lanes, COVID-19 restrictions as well as general economic uncertainty caused major disturbances in the flow of goods. The war in Ukraine further compounded these issues by cutting off the supply of critical raw materials and ratcheting up energy costs. These disruptions have caused several challenges and opportunities for commercial real estate as the industry focuses on restoring the reliability of the global supply chain. Here are three of the most significant impacts: Rising demand for warehouse space During the pandemic, many companies struggled to restock in-demand products driven by a steep increase in online orders amid global lockdowns. Once lockdown restrictions loosened, this led to an “inventory bullwhip effect” as companies over-purchased merchandise to avoid future inventory shortages. Sustained supply-chain bottlenecks led retailers to continue over-purchasing—shifting from “just-in-time” inventory management to a “just-in-case” model in an effort to keep more inventory onsite. As a result, the demand for warehouse space skyrocketed. The impact of this rising demand is significant. On one hand, warehouse sellers can get a significant premium for their property if they pursue a sale-leaseback of their real estate. However, companies looking to acquire or rent warehouse space might have a difficult time as vacancies are at record lows—for U.S. industrial properties it’s just 4.1%. Supply chain disruptions causing delays in construction materials also increase the build time for new warehouses, meaning many companies are left waiting several years for the space they need to accommodate today’s surging retail inventories. From an investor perspective, rising demand often translates to low cap rates for well-located warehouses despite inflationary pressures and rising interest rates. However, the shortage in available space also enhances the criticality of these properties to tenants, making them less likely to vacate at the end of the lease term. Re-shoring supply chains Supply chain disruptions highlighted the risk of off-shore operations for many manufacturers. As a result, many manufacturers are making the decision to re-shore their production facilities to protect against such disruptions in the future. In fact, in 2021, a record 1,800 companies re-shored their production operations in the U.S. Companies looking to re-shore production are choosing locations with a high availability of land for development, a large pool of skilled labor and well-developed transportation infrastructure including railways and ports. This has led to an increase in development in the Midwest and South due to both regions’ access to rail infrastructure and seaports respectively. While re-shoring has contributed to the rising demand for warehouse space, it has also opened up new opportunities for investors as companies look to rent existing warehouses in tertiary markets that may not have historically been attractive, but have access to transportation infrastructure and land available for development. Increased interest in last-mile logistics space With limited warehouse space available, companies are having to get creative with their distribution strategies. One such method is through last-mile warehouses, which facilitate the movement of goods in the supply chain to the final destination. These warehouses are typically located close to the consumer and therefore decrease supply-chain costs while minimizing delivery time. As a result, warehouses situated near major highways and bridges that lead into metropolitan hubs are becoming highly in-demand for companies looking to make their distribution network more nimble. This presents an opportunity for investors who own these types of facilities to capitalize on demand and secure high-quality tenants on long-term leases.
Three Ways CFOs are Leveraging Sale-leasebacks to Prepare for a Recession
The U.S. economy has hit some major roadblocks in recent months. Sustained high inflation, supply chain disruptions and rising interest rates have all signaled to economists that we are either in or on the verge of a possible recession. While there is no universal playbook on how to prepare for a possible recession, for companies that own their real estate, a sale-leaseback is one lesser-known, value-extracting method savvy CFOs should consider. In a sale-leaseback a company sells its real estate to an investor for cash and simultaneously enters into a long-term lease. Proceeds from the sale-leaseback can then be used to bolster a business’ balance sheet and provide the financial flexibility to help navigate a volatile economic environment. Here are three ways CFOs are using sale-leaseback proceeds to grow their businesses and prepare for an uncertain future: Pay down debt and improve credit The last thing businesses want to deal with when a recession hits is mountains of debt to pay down with limited cash flows. By pursuing a sale-leaseback now, companies can unlock capital to reduce leverage and improve their balance sheet health. The reduction in leverage helps improve both a business’ debt / EBITDA ratio in addition to debt / capitalization. As a result, companies will have less debt obligations to worry about and may even improve their credit – leaving them better positioned to weather an economic downturn and secure loans at attractive rates in the future should they need to. Redeploy capital to higher ROI business segments It is almost always the case that businesses can earn more by reinvesting the capital locked up in their real estate (an otherwise illiquid asset) into their core business operations. This makes sale-leasebacks an attractive capital tool for almost any business with owned real estate. Common uses of sale-leaseback capital that can boost a business’ returns include, acquiring new equipment, funding R&D, launching new product lines as well as growing their market share in existing business lines through acquisitions. Improving the efficiency of a business while increasing profits will not only help companies endure a short-term recession, but also position the business for long-term success. Unlock financial flexibility for future growth Sale-leasebacks are a unique financing structure as they give a business the opportunity to convert a non-earning asset into growth capital. Sale-leasebacks also typically have no more restrictive financial covenants than a traditional bank loan – providing CFOs with significant discretion in determining the best use of their company’s cash. In a recessionary environment when companies typically struggle with dwindling cash flows, having the extra capital from a sale-leaseback could offer companies the financial flexibility to take advantage of growth opportunities as they arise, setting them apart from their competitors who may be struggling just to stay afloat. Conclusion For many companies, sale-leasebacks are a cost-effective strategy to unlock capital which can help improve balance sheet health and enable companies to invest in growth, positioning them for longevity and success even amidst an economic downturn. Given the rising rate environment, it’s also advantageous for a company to pursue a sale-leaseback now to lock in an attractive long-term rental rate before interest rates likely rise again in the fall. Ultimately, preparing for a recession comes down to preparation. By making strategic business choices now, CFOs can prepare for an uncertain future.
Inflation Pumps the Case for Sale-Leasebacks
Money isn't worth as much these days, but it's not getting any cheaper for businesses seeking growth. Facing 40-year-high inflation, the Federal Reserve has gone from 25- to 50- to 75-bp rate increases. Loans may no longer make sense for cash-strapped companies. That said, continued inflation could make a sale-leaseback an attractive alternative, according to Tyler Swann, managing director at W. P. Carey. "A sale-leaseback allows you to lock in your cost of capital for a very long term," says Swann. "If you take the view that interest rates are going to continue to rise, locking in that cost of capital today could be very valuable for you." A sale-leaseback is when a business sells its real estate for cash and leases it back on a long-term basis from the seller. Often, the buyer-landlord is a REIT or other institutional investor that is equipped to make the most out of a real-estate asset. The seller-lessee company, meanwhile, benefits by being able to invest the value of the asset into the business. Swann makes the general case for sale-leasebacks more succinctly: If you're not in the business of real estate, why be in the business of real estate? "It is almost always the case that an owner of a business can earn more on reinvesting money in their business than they can on having that money locked up in real estate," says Swann. "It's more capital-efficient to have that building owned by investors who want to take that risk specifically." This two-way street of capital efficiency is heightened in the inflationary context because of how a business's needs differ from those of an investor. "Because of the Fed's aggressive stance on raising rates, short-term rates are probably going to rise pretty meaningfully in the next six to 12 months," says Swann. "But because the investments that we're making are such long-term investments, we're locking in our returns and borrowing costs for a very long period of time. So we're most focused on what long-term interest rates look like." When considering a sale-leaseback, Swann recommends that would-be seller-lessees consider the property's capitalization rate against such factors as the proposed lease term and rental-increase schedule -- as well as against the market as a whole. In an inflationary environment, this latter juxtaposition can be striking. "If you look at the broader debt markets, particularly high-yield debt markets, they're in very bad shape right now. Interest rates for high-yield debt have skyrocketed recently," says Swann. "And that has made sale-leaseback financing, [where cap rates have] not risen nearly as much, a much more attractive option on a relative basis."
Retail Revitalization: Key Takeaways from ICSC Las Vegas
After a two-year hiatus, ICSC Las Vegas – one of the largest conventions for the retail industry – made its big comeback with over 22,000 attendees getting together to discuss the opportunities and trends in the sector. Retailers, brokers and real estate investors were among the exhibitors on the conference floor, where a number of topics dominated the discussion. Rising rates and inflation, the retail recovery and resurgence of brick-and-mortar were among the biggest themes at the conference. Here’s an overview of each: Financing amid rising interest rates and inflation Inflation continues to rise at its fastest pace in 40 years, with the consumer price index reaching 8.6% for the 12 months ending in May. Interest rates have also been surging, with the Fed raising benchmark rates in its most aggressive hike since 1994. This challenging and volatile economic environment has made it difficult for retailers to secure traditional debt financing at attractive rates. However, one method of financing that has been gaining traction in the retail sector is the sale-leaseback – where a company sells its real estate to an investor for cash and simultaneously enters into a long-term lease. Big names such as 7-Eleven, Sherwin Williams and Mister Car Wash have made sale-leasebacks a core part of their growth strategies due to the ability to quickly unlock otherwise illiquid capital and reinvest those proceeds into their business. Retailers can also lock in a long-term rental rate which is especially advantageous in the current economic landscape while not having to worry about short-term refinancing or restrictive debt covenants. Retail revival Despite the challenging market environment, there was a lot of optimism for the retail sector at ICSC Las Vegas. Virtually all retail property types from grocery to c-stores experienced an increase in leasing activity over the past year – with retail tenants absorbing 91 million square feet of space nationally over the past 12 months. Furthermore, the retail sector is now seeing the lowest levels of bankruptcy filings in the past five years in addition to a steady uptick in foot traffic in physical stores. This is indicative of a larger retail recovery, leaving the sector in its best position since the pandemic began. Resurgence of brick-and-mortar Perhaps the biggest topic of discussion at the conference was the resurgence of brick-and-mortar retail. While many had predicted that e-commerce would be the way of the future, consumers have proved them wrong by returning to physical stores en masse. In 2021, retail sales totaled $5 trillion – with only about 13% of that stemming from e-commerce. Online shopping actually decreased year-over-year, demonstrating that consumers were eager to return to physical stores as the pandemic subsided. This increased demand also spurred many existing retailers to expand their store footprints and some online-only retailers to open physical stores. However, not all segments within retail are created equal, with some property types like movie theaters continuing to struggle while others like restaurants have thrived. Regardless, retailers have continued to adapt to meet the evolving demands of consumers, with omnichannel – a combination of e-commerce and brick-and-mortar – emerging as the prevailing strategy for success. Conclusion Despite a challenging few years for the retail sector, fundamentals continue to improve in 2022 as demand for high-quality retail assets returns and retailers look to cash in on owned real estate to improve balance sheet health and fund future growth. Interest rates, inflation and a rumored recession lingered in the air at this year's ICSC Las Vegas, but attendees were confident that the retail revival is underway.
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.
Fighting Back Against Inflation with Real Estate
Inflation is at its highest point in 40 years. The consumer price index – a key indicator of inflation – rose 7.5% in the 12 months ending in January, far surpassing initial predictions from economists. For CFOs, this has meant a rapid increase in the cost of raw materials, manufacturing and overhead which significantly cuts into a businesses’ cash flows. In addition, the US is currently in the midst of a labor shortage stemming from the COVID-19 pandemic. This has forced CFOs to increase wages and other compensation in order to secure and retain talent – another big blow to a company’s cash flows. To fight mounting costs, CFOs need to take a look at their company’s assets and find ways to free up capital on their balance sheets. One often overlooked asset is a company’s owned real estate. For companies not in the business of owning real estate, these assets add a significant weight on the balance sheet. However, through a sale-leaseback, companies can sell their real estate to an investor for cash while simultaneously entering into a long-term lease. The benefit of this type of transaction is that companies can realize 100% of the value of an otherwise illiquid asset and can immediately invest that capital back into their core business. In today’s high-inflationary environment, this capital could be used to offset immediate rising wholesale and labor costs in addition to funding long-term growth initiatives. Furthermore, companies can retain full operational control of their assets following a sale-leaseback, meaning there’s no disruption to day-to-day business. Now is also a particularly attractive time for CFOs to consider sale-leasebacks due to a number of macroeconomic factors. First, the U.S. Federal Reserve has signaled that they plan to raise interest rates as early as this month to counteract inflation. However, if a company pursues a sale-leaseback now, they can lock in today’s lower rates on a long-term basis. Second, competition for high-quality real estate – particularly industrial assets – remains at an all-time high due to investors seeking long-term, stable cash flows. As a result, corporate owners can secure a high price for their real estate, in addition to attractive lease structuring, giving them the opportunity to fully maximize the amount of proceeds they receive. Inflation certainly won’t last forever, but even a few months, or years, of rising prices can be devastating for businesses. While there are a number of tools CFOs can leverage to mitigate the impact of inflation, sale-leasebacks should not be overlooked. Unlocking the value of corporate real estate and reinvesting those proceeds back into the business can not only help companies ride out the current wave of rising prices, but also set them up with the capital needed for long-term growth and success.
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.