Struggling to find capital as the credit markets tighten and the U.S. economy slows, corporations are increasingly exploring sale-leaseback deals to finance growth, repay debt and fund operations. But falling commercial real estate prices and growing worries about the creditworthiness of many corporations have curbed deal volume.

Against that backdrop, sale-leaseback buyers are redoubling their efforts to capture the highest-quality deals. That means investors are pushing for property prices and rental rates low enough to compete in the event a tenant goes under, particularly when betting on stronger operators in relatively weak industries.

Case in point: National and regional banks are unloading their real estate with more frequency to help address deteriorating fundamentals in their loan portfolios and a host of other balance sheet issues.

The Federal Deposit Insurance Corp.'s latest report says that the non-performing loan rate among institutions it regulates more than doubled to 2.04% in the second quarter this year over the same quarter last year.

In July, Inland Real Estate Group in Oak Brook, Ill. and an affiliate acquired four Bank of America office buildings totaling 840,000 sq. ft. for $152.6 million. Inland also snatched up 433 SunTrust Bank branches for $736 million in December 2007 and April 2008.

“When you're doing sale-leasebacks with banks, you've got to be darn sure you're dealing with financial institutions that are going to be around for a long time and that haven't had to drastically write down their books,” says Joseph Cosenza, vice chairman of Inland Real Estate Group. “That's something we watch very closely.”

Yet on the flip side, the credit crisis is forcing some corporations that generally would have avoided sale-leasebacks in the past to consider them, he adds. A broader acceptance of the strategy by companies coupled with the demise of synthetic leases also is driving transactions.

“Two years ago I certainly wouldn't have gotten $153 million worth of Bank of America properties,” says Cosenza. “These are telling times.”

Market in flux

In a sale-leaseback deal, corporations sell real estate they own and then rent the properties back from the buyers under a long-term net lease — roughly 15 or 20 years — with extension options. But it's not uncommon for leases to be signed for as little as 10 years.

Under the arrangement, tenants are responsible for the property's operating and capital expenses such as taxes, insurance and maintenance. For investors, sale-leasebacks typically generate returns of 300 to 500 basis points over the 10-year Treasury yield.

Among other benefits, sellers move the assets off their balance sheets for tax purposes and receive predictable long-term lease rates. Most critical, companies pocket cash they can plow back into their business to fund growth or pay off debt.

Like the broader commercial real estate investment sales environment, sale-leaseback transactions have declined over the last several months. Boulder Net Lease Funds in Northbrook, Ill., a private equity firm that tracks net-lease sales activity, reports 15,500 net-lease properties changed hands in the first half of 2008, down nearly 14% over the same period last year. Sale-leaseback transactions are considered a subset of net-lease deals.

But Jeff Rothbart, a principal and research director at Boulder Net Lease, suggests that the number of reported net-lease transactions this year is likely skewed to the high side. Some corporations are simply putting their assets on the market to test pricing and are artificially inflating supply, he says. The companies are then balking at offers and taking the assets off the market, leaving the impression that the properties have sold.

What's more, the seized-up mortgage markets and a higher cost of capital have benched many sale-leaseback buyers who at one time tapped cheap debt to finance 80% or more of their acquisitions, experts say. Some investors claim sellers need to capitulate on price to spark more deals.