Sale-leaseback
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.
To Have and to Hold
The net lease market is firing on all cylinders with record capital raising, persistent demand for reliable cash flows and the emergence of new players seeking low-maintenance assets offering predictable income and long-term leases. Aggressive market dynamics are driving cap rates to historic lows, making now an opportune time for sellers and private equity owners to unlock a lower cost of capital through a sale-leaseback of corporate real estate vs. traditional financing. However, with new sources of capital entering the market, it’s more difficult for sellers to navigate the expanding buyer pool and choose a capital partner that’s truly “the one.” In addition to more traditional net lease investors like public REITs, private and institutional investors have continued to grow their share of the net lease market. According to CBRE, institutional and equity funds accounted for $6.3 billion in volume in the second quarter of 2021, a 99% increase from the prior year. The steady performance of the sector coupled with attractive market dynamics position these funds well for an easy flip of their investments a few years down the line. However, this does not always leave sellers well positioned to take advantage of the full suite of benefits a sale-leaseback can offer if done so with the right partner. In order to choose the right buyer, sellers should ask themselves these three questions before settling down: 1. Does my company need flexibility over the long term? Unlike a fund, a long-term holder isn’t looking to hit a short-dated return hurdle and flip the asset 4-6 years down the line. Whether it’s a potential merger or subleasing underutilized space, a long-term landlord focused on deploying additional capital to support the evolving needs of its tenants may be a better fit than a short-term holder focused on disposition opportunities. 2. Is my company growing? While many tenants prefer quiet enjoyment of their space, having a landlord aligned with growth can be key. If a tenant wants to expand their existing facility to add space or make sustainability enhancements, a landlord aligned with long-term growth is happy to continue investing in the facility in a way that’s going to support the needs of its tenants and improve the long-term value of the property. 3. Do I understand the buyer's underwriting process? Most long-term investors will spend the time to get to know a business and its unique structure rather than relying solely on credit ratings or focusing on the real estate alone. This is particularly important for sub-investment grade or non-rated companies to ensure they are being valued appropriately during the underwriting process and able to maximize sale-leaseback proceeds. Conclusion Whether you’re a company looking to sell one asset or a portfolio of assets, it’s a big decision. Before jumping into that commitment, it’s important to remember that at the core of any relationship should be a true partnership. This means choosing a partner that will recognize the full value of your real estate from the start and support your evolving needs.
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-leasebacks Are Back!
The sale-leaseback market is booming. Strong fundamentals including low interest rates, outsized demand for high-quality assets, an active M&A market and significant amounts of capital driven by cheap debt and strong currency make now an opportune time for sellers to execute a sale-leaseback and unlock otherwise illiquid capital tied up in their real estate. According to data from SLB Capital Advisors, sale-leaseback activity increased 17% in Q2 from the previous quarter, reaching $3.6 billion–the second highest in terms of deal volume since before the pandemic in Q4 2019. With interest rates unlikely to rise in the short term and property valuations being pushed higher as new investors enter the sale-leaseback market, we expect this high level of activity to continue into 2022. However, within the broader sale-leaseback market, each core property type–industrial, office and retail–faces unique headwinds and tailwinds, presenting new challenges and opportunities across each. Here’s how we think each will fare in 2022. The Industrial Surge The industrial real estate market continues to be one of the strongest sectors fueled by tailwinds related to the growth of e-commerce, including increased inventory requirements and record-low vacancy rates. These strong fundamentals mean that investor demand for industrial sale-leasebacks will only increase, particularly as new entrants enter the market. We are already seeing the effects of this–but as more entrants enter, the imbalance between the product available and demand for assets will continue to widen, driving prices higher and cap rates lower–even in traditionally non-core industrial markets. In addition, a lag in new development due to increased material and labor costs will keep real estate valuations for existing assets high. As a result, we don’t see the industrial market slowing any time soon–creating immense opportunity for sellers to maximize the value of their real estate through a sale-leaseback. Growing Office Optimism While office has certainly been a dark horse in the real estate market due to lockdowns and work-from-home mandates, there’s some optimism on the horizon going into 2022. Several big tech companies such as Google, Facebook and Amazon, have made investments in NYC office space this year, sparking early signs of recovery in the sector. In addition, Sun Belt markets such as Texas and Florida–where many urbanites migrated during the pandemic–are seeing an increase in demand for offices supported predominantly by the small and mid-size businesses located in those regions. For potential sellers, these are all positive signs and suggest that investor demand for certain office assets will rise in 2022, particularly for high-quality properties in strong markets leased to investment-grade tenants. Retail's Road to Recovery Similar to the office market, retail is seeing a recovery from COVID-19 pandemic lows. Retail foot traffic and sales continue to increase, but the rise of e-commerce has certainly left a lasting impact on the industry as a whole, as most retailers are now implementing hybrid store models which include both brick-and-mortar stores and online distribution. In the next few years, many retailers will likely reevaluate their portfolios in terms of number of stores, location and use–and many may downsize as online orders become a greater proportion of their sales. As a result, the overall level of occupied retail space will likely shrink, meaning the market will favor corporate sellers and tenants. In addition, we expect investor demand for essential retail such as grocery and quick-service-restaurants will remain strong in 2022, as those sectors have demonstrated exceptional resiliency during the pandemic and resulting economic downturn. We’ll likely also see an increase in volume of retail sale-leasebacks in Europe, particularly for those essential assets, as US-based investors expand into new markets to take advantage of different costs of capital. What's Next Overall, the outlook for sale-leasebacks remains positive across all three core property types, with 2021 shaping up to potentially be a record year for deal volume. As long as the market fundamentals remain strong, corporate sellers pursuing a sale-leaseback will be able to secure high valuations for their real estate assets while locking in current low rates for the long term. Working with an experienced sale-leaseback investor such as W. P. Carey ensures sellers unlock 100% fair market value of their assets–which can be reinvested into growth initiatives–and also provides a long-term capital partner that can support future real estate needs.
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.
The Appeal of Industrial Sale-leaseback Transactions
Let’s start with the foundation: if you’re unfamiliar with the term sale-leaseback, you should go here. For a more focused explanation relating to industrial properties, let’s turn to Erik Foster, principal with Avison Young and head of the firm’s industrial capital markets practice. “A sale-leaseback is when a user of real estate who owns their premises chooses to monetize that real estate. They stay in [the property], occupy it for a long term and sell it to a third-party owner who becomes the landlord, and the occupier becomes a tenant,” Foster told LoopNet. According to Foster, sale-leaseback transactions for industrial assets have been surging over the past several years, with interest in North American industrial properties emanating from across the world. “It’s truly become a global marketplace,” Foster said. This interest in industrial real estate is neither new nor particularly surprising. As Foster noted, the sector has been experiencing record low vacancies amid historic levels of investment activity. And these factors, which have intensified during the pandemic, have created what Foster described as “a very exuberant investment atmosphere.” And industrial users are increasingly taking note of this enthusiasm. Historically, industrial users have been more apt to own their facilities than their office or retail counterparts. Where most office and retail properties are typically developed with the expectation that multiple tenants will occupy the property, some types of industrial properties are more commonly utilized by a single user. Moreover, industrial properties are often heavily customized to meet the manufacturing or specialized logistical requirements of a particular business. But industrial users are beginning to realize that they may be able to possess their proverbial cake and consume it too. “Industrial users are finding that they can reap the rewards of the sale of their building at record pricing, but still maintain occupancy and the use, so nothing really changes for them,” Foster said. Of course, few things in commercial real estate are without caveats. To gain a better understanding of the industrial sale-leaseback phenomenon, LoopNet spoke with Foster — as well as Gino Sabatini, head of investments and managing director of W. P. Carey — and they walked us through the attributes and challenges of this process for both users and investors. An Opportunity for Industrial Users to Acquire Capital and Flexibility According to Foster, for the industrial user, most of the advantages of a sale-leaseback transaction can be reduced to two concepts: working capital and flexibility. Foster noted that most industrial users that own their property have some kind of financing tied to the building. Perhaps they have a loan that represents 50%, or even 60% or 70% of the building’s appraised value. This loan provides them with operating capital to reinvest into the business — for the purchase of equipment or materials, for instance. Through a sale-leaseback transaction, a user can derive 100% of the value of their property, and reallocate that capital to other aspects of their business. Depending on the company’s accounting structure, this could vastly improve their balance sheet. “You can pay down debt, you can reinvest into your business,” Foster said. Meanwhile, the company in question retains use of the asset. The user “gets a ton of capital out of the real estate and continues to use [the real estate] the way they always have,” Foster added. The industrial user also enhances their flexibility in the process, trading their real estate asset for “a leasehold obligation. It’s not an illiquid asset,” Foster said. Between record-setting industrial investment activity and equally historic low interest rates, this can seem like the ideal moment for industrial users to relinquish ownership of their facilities. “W.P. Carey, and most other sale-leaseback and net-lease buyers, operate on a spread over interest rates,” Sabatini said. This means that as interest rates potentially rise in the near(ish) future, cap rates could climb alongside them. Currently, Sabatini said that cap rates range from 4% to 7%, depending on the location and nature of the facility (more on that in a moment). Foster said that he was even “hearing about sub-3% cap rates on the coasts.” All of these factors may make an industrial sale-leaseback transaction seem like a “best of both worlds” scenario for the user, but it’s not quite that simple. For one thing, as most industrial users are typically real estate novices, they need to make sure they carefully consider all potential suitors. “The user needs to make sure that they don’t talk to the first person that knocks on the door,” Foster said. According to Foster, taking the property through a traditional investment sales process generally garners terms that are more beneficial to the user — both for the sale and the subsequent lease. “When we go out and we make a market for assets like this, we’re amazed at how the terms continue to become better as we work through the process. Foster mentioned that it’s also important to find the right investor match for each particular industrial user. “Sometimes this is their only location and its critical to the [tenant/seller], so having an owner who doesn’t have any forethought or care about the user is an issue too, so you’ve just got to find the right match.” Industrial users also need to be comfortable with the control they’re surrendering by entering into a sale-leaseback transaction. For users that are accustomed to having sole authority over their premises, that adjustment could potentially be challenging. And, as frenetic as the industrial sales market is at the moment, there are reasons to believe that prices could continue to rise. “With the shortages in the commodities markets and the difficulty in getting steel and lumber and other materials, there’s a bit of a governor on the amount of development that can happen. So, the supply of assets is also muted, which is continuing to drive scarcity pricing,” Foster said. Ultimately, the viability of a sale-leaseback transaction for an industrial user will come down to that particular company’s priorities and whether they value working capital and flexibility over control and security. For investors, the calculus is a bit more fraught with risk, but potentially equally rewarding. Conducting Due Diligence on an Industrial Sale-Leaseback Opportunity It’s probably fair to say that W.P. Carey has more experience in industrial sale-leasebacks than any other property owner; after all, that’s been the firm’s primary focus since it was founded in 1973. As Sabatini described it, “Sale-leasebacks of industrial buildings for sub-investment grade companies is really our bread and butter.” When LoopNet asked what made these investments so appealing to W.P. Carey, Sabatini explained, “The facilities are often very critical to the company that is doing the sale-leaseback, and that’s very important for us; because we’re a long-term holder and we want to own something that the company is planning on using for a long period of time.” In an ideal scenario, Carey [Note: have requested that they change to Sabatini] said that W.P. Carey’s investment thesis is relatively simple. “We’re making a bet alongside the equity investors in that company that the company is going to be successful for a long period of time. If we’re correct, then we’ll collect rent for a 15- or 20-year primary lease term for starters, and potentially [execute] renewals as well.” But what happens if they're wrong? According to Sabatini, that depends largely on the market and asset in question. A highly customized property, one that will be challenging to adapt for a new tenant — such as a food or biotech manufacturing facility — represents a greater risk than a relatively generic property, like a last-mile fulfillment center. That risk expands in smaller markets and is somewhat ameliorated in larger markets. In terms of how Sabatini approaches the due diligence process, he said that the first portion of his methodology involves elements that are fairly consistent across any real estate asset class or deal type. He advised that prospective investors commission an environmental phase I study (and a phase II study if the initial report reveals any areas for concern); have an engineer walk the property to appraise its structural integrity; and review the property survey and title. “Make sure you’re purchasing a clean piece of real estate,” Sabatini said. After that, you need to undertake what Sabatini says is often the more challenging facet of the process: reviewing the company who will first sell you the property and then become your tenant. Sabatini likens this phase of due diligence to the process credit organizations like Moody’s undertake when they’re rating companies. “You try to understand the industry, the company’s position within it, as well as any threats to either the company or the industry,” he said. “You really need to dig into the credit and understand why the building is important to the company, and what the company’s financial prospects are in the short-term, the medium-term and the long-term.” Sabatini also said that it’s important to carefully review the company’s balance sheet. Specifically, you should assess their attitude towards leverage and how they have fared during downturns. As this process illustrates, in many respects a sale-leaseback transaction isn’t a simple real estate deal; it’s more analogous to the creation of a (hopefully) long-term, mutually beneficial partnership.
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.