What is happening with sale leaseback?
There was a 92% increase in sale leaseback volume in 2021. The 2022 outlook appears to be equally strong with numerous multi-billion-dollar buyouts of sale leaseback portfolios by major funds announced in the last month.
What’s the attraction?
Government funding programs have run their course. Many businesses have turned a corner, but still need a boost or a bridge. With the onset of runaway inflation and protracted international conflicts again destabilizing supply chains and markets, raising equity is a challenge and anything but a near-term solution. Companies with untapped equity in real estate holdings can quickly monetize this asset, reset their financial position, and pursue longer term objectives with liquidity.
Where are the banks?
Banks are always looking to support a customer, but borrowers may come to realize the loan-to-value banks offer on real estate is less than compelling, especially when the owner has a higher risk profile.
Unequivocally, banks do not want to be landlords. They manage “loan” portfolios not “real estate” portfolios and regulators want to make sure it stays that way. The greatest bank crises in history were tied to real estate.
Enter Private Equity on both sides of the table.
First, PE is driving businesses they own to leverage untapped equity so precious “deal” capital can be preserved and their investment minimized during unstable times.
Second, PE, a quick study of market opportunity and need, is becoming a major player in financing the transactions their brethren (operating funds) are generating.
With ample idle capital, no regulatory headwinds, and a very nimble corporate structure of very strategic thinkers, PE is quite adept at developing and managing portfolios, as well as maximizing investment yields in secondary markets. Presently, they are investing in talent and approaching markets with a specific strategy that redirects the fees and commissions of realty intermediaries to their bottom-line.
When is Sale Leaseback the right move?
Great question, and it is far from black and white. No owner or situation is the same. A leaseback may be a sub-optimal path for managing major real estate holdings and perhaps the business to some extent, but the liquidity may be transformative and thus overcome any adversity. Transformative may include securing adequate time to: recruit capital and avoid a forced sale or liquidation, grow operations and stabilize the business, or take advantage of any lucrative opportunity that is time sensitive.
As noted above, a PE operating group might drive real estate asset monetization to preserve liquidity and manage their at-risk capital. Their foray into a business is generally not incremental. They are seeking to reap significant value through expansive growth that dwarfs any cost of a shortsighted decision in managing an asset. Other ownership structures may have a different point of view and approach.
A family owned, or privately held business, for instance, may have a more modest growth opportunity and exit path. Real estate asset appreciation may be a more meaningful source of value to ownership and actual contributor to selling the business as owning and controlling the facility and its potential strategic location (to customers, workforce, rail, or distribution channels) may be critical to attracting a buyer.
We recommend doing the full math (all considerations, including operational), exploring all options (there are others, see below), knowing your buyer (reputation as a buyer and a landlord), making it a competitive process, and ensuring accountability throughout the process which is best achieved when the buyer sees the seller has options.
Managing the Leaseback Process
If you go the sale leaseback path, realize you are in a process of going from owner to a tenant. We again emphasize “know your landlord,” understand what you need from the facility you are looking to sell (near-term, long-term, strategically). This includes deferred repairs and maintenance (which illiquid companies so often have), near-term or future capital improvements that may be required (often material) under ordinary circumstances, as well as to operational investments required to support potential growth.
If you are selling real estate, there will be a commission or lead fee that is not insignificant. There will be taxes to pay, and then there will be the newly negotiated rental costs, and an assortment of unanswered questions. Know what you are left with, how long it will last and how it can change (escalation in rent, management fees, real estate taxes, and maintenance costs).
Additionally, realize that fees, costs and conditions may get tacked on as the transaction evolves if proper effort and protections are not put forth on the front end. If you do not have the time to reboot the process or circle back to another bidder, you will not have the leverage you need to correct the deal so think it through completely and do not get complacent. Otherwise, you may be forced to accept a deal you would have rejected on the front end.
Are there alternatives?
As a matter of fact, there are, and they can be quite attractive. There are a growing number of non-bank players in this niche market. They will lend to owners who are the anchor or sole tenant of a facility and provide very clear parameters.
Their loan to value can go as high 75% and ultimately provide a business more short-term liquidity than a sale leaseback, and at a lower future cost (loan vs. lease) with the borrower preserving control and upside on a property that is likely central to the business’s operations and ultimate value.
Need some guidance? We can help.
Contact Harney Partners We have a 30+ year history of serving companies as a financial advisor in a host of technical and operational areas.