What’s Behind Food Production’s Interest in Sale-leasebacks
The sector is tapping the funding source as it eyes further growth, writes W. P. Carey’s Pasanen
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.
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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- The Ins And Outs Of Sale-Leasebacks| W. P. Carey. 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.
Why Food Retailers Should Consider Sale-leasebacks to Support Growth Strategies
As many retailers nationwide are forced to close down and reduce property footprints due to the ongoing coronavirus pandemic, one particular sector is looking to grow – food retail. Driven by changing consumer habits such as eating more at home and the desire to “stock up” on groceries, food retail has seen growing demand in recent months. In fact, a recent survey showed that consumers are spending 37 percent more per grocery trip than they did before the pandemic. In addition, while in-store shopping trips have declined, digital sales continue to boom – with US online grocery sales hitting a record $7.2 billion in June, up 9 percent from May’s $6.6 billion. Despite many food retailers being spared from the financial repercussions of the pandemic, the swift shift towards online shopping has driven savvy retailers to bolster their omnichannel shopping strategies and capitalize on the newfound demand for online delivery. To implement these changes and adapt to growing demand, food retailers will need growth capital for critical projects like investing in their online-ordering capabilities and/or expanding their distribution centers to keep up with online orders. One of the simplest and most effective ways retailers can secure this capital is by leveraging their existing real estate assets and pursuing a sale-leaseback transaction. In a sale-leaseback – or “sale and leaseback” – a company sells its real estate to an investor for cash and simultaneously enters into a long-term lease. In doing so, the company extracts 100 percent of the property’s value and converts otherwise illiquid assets into working capital to grow its business, while also maintaining full operational control of its facilities. One major benefit of a sale-leaseback is that it is generally a long-term commitment, meaning companies can realize high prices for their assets in the current low-yield environment and also lock in low rent for years to come. In addition, companies can gain a long-term capital partner that can fund future expansions and development of new facilities. Because of these benefits, it’s not surprising that several savvy food retailers have already pursued sale-leasebacks as part of their growth strategies on a stand-alone basis or in conjunction with private equity firms and other investors. W. P. Carey is one of the largest diversified net lease real estate investors, with a portfolio comprising over 1,200 properties across both the US and Europe. W. P. Carey has nearly 50 years of experience partnering with creditworthy companies on sale-leasebacks ranging from $5 million - $500 million to help unlock otherwise unused capital tied up in their critical real estate. As consumer habits continue to change due to the pandemic – likely for the long haul – there’s never been a better time for food retailers to undertake a sale-leaseback. Those that do will be able to secure the growth capital they need to expand and meet growing consumer demand and expectations – putting them ahead of the curve and onto the path of long-term success.