Real Estate Monetization
What’s Next for Commercial Real Estate?
After several challenging years contending with the impacts of a global pandemic, the commercial real estate market finally seems to be healing. As noted in the latest Emerging Trends in Real Estate report from PwC and the Urban Land Institute, the Fed's 50-basis-point cut in September and subsequent 25-basis-point cut in November have generated some optimism in the CRE community that we are entering a new expansionary phase in the real estate cycle. Here are four of the top emerging trends taking shape as a result. 1. Interest Rates and Capital Cost Concerns Have Eased, but Still Remain In the aftermath of the global financial crisis of 2007-2008, the Fed attempted to revive the economy by lowering the federal funds rate to near zero. What followed was nearly a decade in which cheap debt became a way of life. However, starting in the spring of 2022, with inflation surging, the federal funds rate was increased 11 times, pushing the rate from zero to over 5 percent, bringing real estate investment activity to a near standstill. Reflecting on the market today, interest rates and cost of capital remain among the top concerns of respondents to the PwC Emerging Trends in Real Estate survey, but those concerns have eased since last year. While respondents largely agree that the rate cuts so far are not enough to alter deal economics fundamentally, the monetary policy movements have still injected optimism into the market. In addition, more than 80% believe that commercial mortgage rates will decrease in 2025, with 75% believing those rates will continue to decrease over the next five years. As an industry that relies heavily on leverage to get deals done, signs of lower-costing debt bode well for the future and will support more robust deal volume. That said, the Fed’s future decisions on rate cuts will depend on how inflation and the overall economic outlook evolve. 2. Acquisitions, Refinancing and Development Markets Improving The acquisitions, refinancing and development markets are slowly starting to heal, the Emerging Trends report noted, pointing to steady improvement in liquidity and more bids in the market, as well as tighter prices and debt spreads. Industry participants are also optimistic about debt conditions ahead, with lending expected to grow by 24% in 2025, indicating a full recovery to pre-pandemic levels and further signaling that normalization and stability are on the horizon. Another key factor market participants are looking at is the stabilization of recent real estate price declines. Cap rates began rising when prices peaked in mid-2022 and continued increasing until plateauing in early 2024. The most recent figures suggest prices might be turning positive again, although this may simply reflect that higher-quality real estate is accounting for a larger share of transactions. 3. Occupied Space Now Exceeds Pre-Pandemic Levels in Most Sectors The pandemic created significant changes in how tenants use space, and where. There are fewer office workers commuting to the workplace, more consumers shopping online and more goods being stored in warehouses. However, despite these changes, overall demand for space has more than recovered from the pandemic and remains robust across most property types, with the exception of office. When looking at the future of the retail market, survey respondents indicated that location is key. While newness is a significant priority for some property types like office, retail spaces tend to derive much of their value and demand based on their location. Frequently, older retail centers command the best locations, preventing newer entrants from gaining a foothold and making them more attractive to investors. In the industrial sector, net absorption has been positive, meaning more space is occupied than ever before. Yet demand has not kept pace with new supply, leading to an increase in vacant space. This has given more negotiating power to tenants, who are increasingly seeking spaces with more modern features such as high energy efficiency, LED lighting and higher clear heights. However, this “flight to quality” trend should abate slightly as the pipeline for new product slows and the supply/demand dynamics balance out. 4. There Is Less Movement Due to the High Costs of Relocation The pandemic not only created a shift in the demand for commercial property, but also shifted where people want to live and work. After years of increasing interstate migration, many areas are experiencing slower population growth or even outright population losses due to soaring home prices, fewer renters having the ability to transition to home ownership, and fewer households relocating for new jobs. The report notes that climate change is also becoming a greater factor in location decisions. The report points to a Freddie Mac analysis that shows natural disaster concerns have prompted one in seven households to consider other places to live. Many commercial properties are also at risk of damage from natural disasters and commercial property owners are facing increasing insurance premiums as a result. Conclusion As the real estate market transitions into a new cycle in 2025, we remain cautiously optimistic for the future. With change comes opportunity, and we’re excited to see how the landscape evolves as we enter a phase of recovery and renewal. With more than 50 years of experience operating in all market cycles, we’re well positioned to continue helping companies unlock otherwise illiquid capital from their real estate assets. If you're interested in learning more, contact us today.
What the Latest Rate Cuts Mean for the Net Lease Sector
The persistent high cost of capital, along with the fact that large amounts of corporate debt are set to mature, have been ongoing challenges for investors. The Fed’s recent rate cut – the first in over four years – leaves many speculating how investors will fare. “Impacts from these changes will take some time to see,” says Zachary Pasanen, managing director, investments, at W. P. Carey. “I don’t necessarily believe we’ll experience a rush of investment overnight. Everyone is still in the process of figuring out what the environment will look like, and there are also geopolitical situations at play.” Cap Rates and Market Sentiment Pasanen suggests a positive outlook for the net lease sector, noting that while volumes are down compared to the previous year, the sector’s resilience remains. He explains that net lease investments function similarly to bond instruments, and with rates being cut, he doesn’t believe the risk profile changes that dramatically. “I think the risk paradigm is still very much in that 7%-8% cap range,” says Pasanen, noting that while conditions may eventually spur more net lease activity, it won’t take place immediately. He also cautions that investors should not get too caught up in “rate cut mania” and risk comprising spread. Focusing on fundamentals and maintaining a disciplined investment approach remain as important as ever. Relaxed Interest Rates and the Financing Landscape Funding business growth and quickly accessing capital have left many corporates looking for alternatives to traditional financing. With the Fed’s recent rate cut, Pasanen believes that sale-leasebacks will continue to be an attractive option. He further notes that while there have been pockets of “stress” in the market, these aren’t the same as “distress.” “Many lenders were willing to accommodate borrowers and work with them,” says Pasanen. “This group made it through this past year and is saying, ‘Okay, I’ve extended the maturity of my debt and identified some dislocation among acquisition targets, and now might be a good time to raise capital and grow my business.’” However, as these businesses return to banks to raise more capital, financial institutions may have reached a limit in how much they can help, a scenario where sale-leasebacks can be beneficial. “W. P. Carey has been in business for over 50 years,” says Pasanen. “We’ve been through numerous market cycles and have a lot of capital to deploy. As the market recalibrates, we’ll continue to do what we do best – work with corporate owners to unlock the value of their real estate through sale-leasebacks.”
‘We’re Bullish On Net Lease Retail’
Investors are flocking to the net lease sector anew as the Fed pauses its rate actions and cap rates stabilize, W. P. Carey’s Michael Fitzgerald told GlobeSt. GlobeSt's Holly Amaya spoke with Fitzgerald at ICSC Las Vegas about the state of retail net lease and what has changed in the sector from last year. In this video, you’ll learn: Why he continues to be bullish on net lease retail, What an increase in cap rates has meant for investment, and How the sector will fare in 2024 and beyond. Watch now An interview with Michael Fitzgerald, W. P. Carey, and Holly Amaya, GlobeSt.com.
Navigating Net Lease Retail
Rising interest rates, increased cap rates, and sluggish deal activity created changes in the retail market over the past couple of years. Indeed, the bid-ask spread left many retail net lease deals stuck in negotiations. “There was a time when buyers and sellers found themselves pretty far apart, trying to find a way to meet in the middle,” says Michael Fitzgerald, executive director and head of US retail at W. P. Carey. “During 2023, we saw volume slowdowns of traditionally marketed sale-leaseback deals, as some sectors experienced 50, 75, or even 80 basis point increases in cap rates.” However, at the start of 2024, Fitzgerald notes that he’s seen a stable flow of developer-fueled deals and a higher demand for liquidity. As the market progresses into 2024 and beyond, understanding its direction can help investors make more strategic decisions. Low vacancy rates, creating new opportunities A recent report found that retail vacancy rates are at their lowest level in two decades, as rents continue to rise. The report compared 390 retail marketers across the United States and found that the national retail vacancy rate sat at just 4%. According to Fitzgerald, low vacancy rates are a positive sign that provides confidence in long-term leases and the ability to quickly replace tenants. “Let’s say a fitness operator signs a 20-year lease,” says Fitzgerald. “If retail vacancies are low, that’s a positive for us if we need to re-tenant, as we can likely replace them with a new tenant at or above the original price without compromising our income stream.” He explains that W. P. Carey typically focuses on finding deals in markets with growing rents, such as Phoenix, versus smaller and less vibrant markets. “When you get into underwriting situations where vacancy rates are low, it often allows us to get more aggressive with the cap rate and other deal terms,” says Fitzgerald. Looking into 2025 and beyond Another factor that could contribute to an uptick in activity is merger and acquisition deals. An increase in M&A typically corresponds to an uptick in sale-leaseback activity, as firms leverage proceeds as part of the capital stack for new acquisitions. Overall, Fitzgerald remains optimistic about the coming months. “I think the retail market will continue to be strong because there’s always compelling fundamental reasons why retailers want to sell their real estate rather than hold it,” says Fitzgerald. He explains that it comes down to retailers not being real estate companies. Businesses can generate better returns for investors by investing in their core competencies, ie. running retail operations, and often find holding onto real estate is a drag on their cash and liquidity. As a result, he predicts continued demand from retailers for creative ways to access that liquidity – such as sale-leasebacks.
Why Consider a Sale-leaseback?
In today’s economic environment cash is king, and businesses both large and small are looking for ways to boost their cash flows. That’s why an increasing number of companies are monetizing their real estate to unlock otherwise illiquid capital through sale-leasebacks. Sale-leasebacks give companies the liquidity needed to address a number of strategic and financial initiatives and are growing in popularity. Here are three of the biggest factors motivating companies to pursue a sale-leaseback now. Cheaper alternative to debt When it comes to raising capital, companies typically have a menu of options to choose from including high-yield bonds, bank debt, equity raising or sale-leasebacks. However, some of these methods have been more negatively affected by higher interest rates than others.For instance, bonds and bank debt have both increased by more than 400 basis points since early 2022. On the other hand, cap rates on sale-leasebacks have risen significantly less – about half as much – making sale-leasebacks a more attractive alternative on a relative cost of capital basis. From a purely financial standpoint, this is driving more companies, particularly those with high-quality, mission-critical real estate assets, to leverage sale-leasebacks as one of their primary forms of capital raising. Capital to reduce leverage Given recent economic volatility, more companies are seeking to strengthen their overall credit metrics and capitalization to best position themselves for the future. Sale-leasebacks are a great solution for companies looking to reduce leverage, as the proceeds can be used to pay down shorter-term debt or maturing debt that has become significantly more expensive to refinance. The reduction in leverage helps improve both a business’ debt / EBITDA ratio in addition to debt / capitalization, which can improve a company’s overall credit and better position them for the long term. M&A financing Company valuations remain significantly lower than early 2022. While this has caused an overall reduction in volume in the M&A market, some businesses are taking advantage of the fact that their acquisition targets may have become cheaper. For companies looking to opportunistically expand through M&A, sale-leasebacks are an excellent tool to add to the capital stack. By pursuing a sale-leaseback concurrently with a new acquisition, the acquirer can reduce their equity check and boosts returns – effectively ‘buying down’ the acquisition multiple. Private equity firms, in particular, are increasingly using this technique for buyouts. Read about W. P. Carey’s recent transaction with SK Capital and Apotex to learn more. Closing thoughts While sale-leasebacks are a great capital tool in high-interest-rate environments, they can be just as useful in less turbulent climates. Freeing up capital from owned real estate – in any stage of the market – is an excellent way to invest in the core competencies of a business and fund internal and external growth objectives. Interested in exploring a sale-leaseback? Contact W. P. Carey today!
Why Net Lease Continues to Draw Investors
The net lease retail sector continues to outperform despite changing interest rates, with a growing number of retailers expanding their footprints or developing new properties against a “compelling” cap rate environment. That’s according to Michael Fitzgerald, executive director, head of US Retail, W. P. Carey, who told GlobeSt at ICSC Las Vegas that many retailers are “aggressively expanding” in their markets. “We’ve seen a lot of activity in sale-leaseback and we are bullish on net lease retail,” Fitzgerald says. “The retail sector is enormous – and we’re chasing deals.” Fitzgerald also discusses: The state of retail fundamentals How investors are responding to changing interest rates and economic uncertainty What makes W. P. Carey stand out from its competitors in terms of investment opportunities Watch now An interview with Michael Fitzgerald, W. P. Carey, and Holly Amaya, GlobeSt.com.
Corporate Capital Outlook - Q1 2023
"The first quarter of 2023 saw significant financial events continuing to cause stress in financial markets, with the Silicon Valley Bank's collapse and Credit Suisse's emergency takeover major contributors. Expected to compound the issue, there is over $2.5tn in commercial real estate debt which will mature in the next five years, with smaller regional U.S. banks holding 70% of outstanding loans to the CRE sector. Rising interest rates and reduced sales volumes will likely cause further defaults in the CRE and banking sector, but overall the global financial system is less exposed compared to the 2008 crash. Q1 2023 experienced the lowest volume of corporate net lease transactions for the past 3 years. The most popular asset class continues to be industrial & logistics followed by office. Despite the sharp rise in European base rates, we have not necessarily seen the mirror image in real estate yields. Written by Colliers Corporate Capital Solutions, the report details the current state of the global economy and capital markets and how that’s impacting the net lease sector. The report also features contributed content from Christopher Mertlitz, Head of European Investments at W. P. Carey, on how corporates can leverage real estate to unlock capital on attractive terms while the debt markets are in flux. Download below to read the full report.
It's Sale-Leaseback's Time to Shine
The current capital environment has tested the adaptability of many companies, as increasing interest rates have made the cost of capital rise uncomfortably. And while it’s unknown if recent events will calm the Federal Reserve’s zeal for future hikes, some companies are already availing themselves of an alternative capital source: the sale-leaseback. In fact, the transaction type matched its 2019 peak in Q4 of 2021, and there are signs it may not be slowing. Zachary Pasanen, managing director, investments at W. P. Carey, sees two big factors playing into the current interest in sale-leaseback: cheaper cost of capital and extra liquidity during tough times. A Corporate Alternative to Expensive Capital A major concern for corporate real estate holders is reducing the cost of capital for the next several years. As Pasanen notes, while they are “not quite desperate yet, the lag between interest rates and cap rates hadn’t caught up six months ago, but it’s starting to now. Prudent CFOs are looking to maximize capital and a long-term sale-leaseback is a great way to do that.” A sale-leaseback offers a “naturally accretive” alternative funding source. Holders of good, fungible, mission-critical real estate that are willing to sign a long-term lease with market or better rental increases built in will likely find that the underlying rate with which they can monetize those assets is inside the going long-term borrowing rate, according to Pasanen. The 50-year-old REIT’s predominant focus has been on warehousing, specialty manufacturing and food production, but it also delves into the education and retail sectors, the latter ranging from experiential sites to fitness-related products to auto repair locations. “By and large, we’ll look at anything as long as there’s criticality to it, meaning the stuff is made at our subject facilities or there’s a really strong location story to it or rent coverage or just a good real estate fundamental story,” Pasanen says. A Liquidity Solution for Tough Times Another consideration facing corporate real estate owners is having the capital on hand to weather the current economic instability. Rates again become a major problem, especially for companies or properties that might be lower on the credit spectrum. “For companies facing challenges that don’t have the ability to finance at attractive rates it’s a very simple calculus: if your borrowing costs go up that’s going to eat into your profit margins and there are only so many levers you can play with when operating a business,” Pasanen said. “They have to be laser-focused on how to get through this period of instability and unknowns.” Sale-leasebacks appeal here as well, allowing companies to put money back into their core competencies or pay down shorter-term debt that’s gotten more expensive, or perhaps even expand given that acquisition targets may have become cheaper. But Pasanen also notes that W. P. Carey’s sale-leaseback business is not just a capital product for troubled times, whether or not it’s on top of mind for companies and owners. “A sale-leaseback is a good tool in good times and a great tool in really uncertain times,” says Pasanen.
The CFO's Cheat Sheet
In anticipation of a potential recession, it's more important than ever for CFOs to find ways to free up cash on their balance sheets. Having a strong balance sheet ensures your company will remain financially stable in any economic condition and allows you to take advantage of growth opportunities that may arise. While there are a number of different strategies CFOs can leverage to improve balance sheet health, here are a few of the most effective. Invest in higher-performing segments of the business—and ditch those that aren't performing By evaluating returns—or losses—from facilities, equipment, plants and other long-term hard assets, CFOs can identify low-performing assets. Selling or repurposing these assets allows CFOs to deploy cash to higher value activities and growth initiatives while delaying capital expenditure, thus improving a company's net income. Review Accounts Receivables and Payables Weak collection policies, slow invoicing, inefficient payment processes and out-of-market terms slows the cash-conversion cycle and ties up cash. CFOs can unlock extra cash for investment, dividend payments, debt payments and mergers and acquisitions by identifying gaps in receivables and payables from the prior year. Usually, a thorough analysis can reveal process gaps, unfavorable and unnecessary terms with customers and vendors and other near-term opportunities, which can help streamline and unlock working capital. Get Smart Credit Support CFOs who use letters of credit, surety bonds and cash collateral as credit support for regulatory or commercial purposes risk misallocating liquidity. A CFO and other stakeholders working with a legal expert can boost a company's liquidity by evaluating—on a regular basis—whether or not all credit support is still required. Where credit support is still necessary, CFOs should always examine the most capital-efficient way for their companies to offer financial collateral. Reduce the Cash Going Out A cash-flow deficit will lead to the eventual downfall of a business. However, reducing the money going out is an effective way to maintain a positive cash flow and improve the balance sheet. CFOs can optimize cash flow by mapping out best-case, worst-case and likely scenarios. If the company's likely scenario is similar to the worst-case scenario, CFOs must find ways to minimize the cash going out to free up more cash. A good starting point for CFOs is to review every detail of a company's Profit & Loss Report and ask the following questions: Why is the company utilizing cash? Can the company achieve this goal more efficiently and cost-effectively? Should the company stop spending the cash altogether? Is there a better deal from this or another supplier? Build Up Cash Reserve Besides managing the cash going out, CFOs need to monitor the cash held closely. This is the money businesses build up to take advantage of an unexpected opportunity or to use during emergencies. Without sufficient funds in reserve, businesses will always find themselves scrambling to secure financing quickly. The general rule of thumb is, until a company builds up its hold or protective balance, a third should be invested back into the business to boost growth, a third should go back into operations and a third should be held. Cash Flow Projection Negative and positive cash flow swings do not have to find CFOs off-guard. CFOs can perform a cash flow analysis to identify trends of negative and positive cash flow swings in a business. This allows a CFO to predict when a company will have a surplus or deficit of cash which helps in planning for the best time to pay expenses. The best practice here is to match a business's cash outflows to the inflows instead of depending on short-term borrowing to cover gaps. This is because, although short-term borrowing has lower interest rates, it still adds to the overall costs of a business. Leasing Equipment and Devices Leasing equipment, devices, motor vehicles and real estate may seem counterintuitive to someone who is only paying attention to the bottom line. However, leasing allows a company to free up more cash because it entails paying in small increments. An added advantage of leasing is that lease payments are considered business expenses and thus can be deducted from a company's tax obligations. Moreover, some devices and equipment can quickly become outdated, inefficient and incompatible with the latest technology. Constantly upgrading or buying new ones to keep up with technological advancements is very costly. Leasing devices and other equipment is an excellent way to stay up-to-date while freeing up cash to invest in high-value projects. Unlock Illiquid Capital Trapped in Real Estate Through a Sale-leaseback One often underused avenue of unlocking capital for company’s balance sheet is a sale-leaseback (also known as a sale-and-leaseback or leaseback). It is a financial transaction where a company sells its real estate to an investor for cash and then leases it from the buyer. When selecting a buyer, it’s important to find an established real estate investor who will value the property accordingly and will pay the full fair market value. Real estate is an illiquid asset that is a drag on many companies' balance sheets— particularly those not in the business of owning real estate. A sale-leaseback enables a company to sell real estate to an investor-landlord and continue to use the property through a long-term lease. Through a sale-leaseback, CFOs can unlock illiquid capital and reinvest it into growth initiatives or other high-performing areas of the business. If you’re considering a sale-leaseback, check out “Is a Sale-Leaseback Right for Your Business?” Conclusion Having a strong balance sheet is critical for several reasons. Ensuring a company has strong cash flows helps support ongoing operations through any economic cycle and gives the company the ability to take advantage of growth opportunities. If CFOs are interested in pursuing a sale-leaseback as part of their balance sheet strategy, working with an experienced partner like W. P. Carey can ensure the company is maximizing the value of their real estate and unlocking 100% of an otherwise illiquid asset. For a real-world example of how a sale-leaseback can be used to support a company’s balance sheet and growth, view a case study here. Think a sale-leaseback might be a good fit for you? Get in touch today!