Last Word

Sale-leasebacks change the face of Corporate America If we assume that there are worthwhile investments to be made in a company's core business -- scientists toconduct research, raw materials to be purchased, sales offices to be opened -- and that operational control of the facilities will remain in the hands of the company, reduced capital costs should be a key factor in the company's decision to either own a facility or enter into a net lease or sale-leaseback arrangement.

Traditionally, real estate departments have been a support or staff function within the corporation. Following the direction of management, leases have been administered, unused facilities sold and new space built. In this environment, service providers function primarily as brokers, executing transactions as they emerge from the real estate department.

Today, the corporate focus on value creation is resulting in a move away from the traditional model toward one that allows for the integration of the real estate department into the larger organization. This presents an opportunity for corporate real estate executives to work with service providers on strategic transactions that impact a number of different areas of the company. For example, in the case of a sale-leaseback the impact can be felt in the following three areas:

It will create sale proceeds which the chief financial officer can reinvest in other, higher yielding areas of the business. Other uses for the proceeds might include buying back stock or redeeming debt. In the case of a net lease for new construction, the CFO will no longer have to allocate scarce capital for a corporate facility.

The transaction can be structured with an operating lease and incorporate below-market or flat rental payments. The result will be to improve the bottom line performance of the business unit. At market rental rates (or even above) it will still improve results if the business unit is being allocated the full capital cost of the facilities being used.

Control and management of strategic facilities will remain in the hands of the company and the real estate department.

While the opportunity to create value through a net lease or sale-leaseback transaction exists for all corporations, it may be more meaningful to capital-constrained companies and leveraged companies that pay more to borrow. The attractive features are the accessibility to capital provided through a sale-leaseback transaction and the flexibility created relative to any existing debt covenants.

Additional corporate considerations include treatment of the gain from the sale of the property and the perception of a sale-leaseback by potential investors looking to acquire a company. If there is a gain, it will be treated as income and taxed at the corporate rate. The tax liability may be large enough to reduce the company's interest in the transaction. However, in the case of new construction, property acquisitions and recently built properties, the fundamental value of the transaction will not be offset by a tax liability.

For those companies that are looking to sell their businesses, they may not want to pursue a transaction like a sale-leaseback that commits them to a long-term lease liability on a facility that may or may not figure in the plans of the acquiring company. In this case, there is less of a reason to re-deploy capital to core businesses when the expectation is that a new management group will be making those strategic decisions in the near future.

Taking a different 'tack' To assist corporate clients in understanding the value of these transactions, service providers need to provide analysis that makes the transaction meaningful within the larger corporate structure and facilitates the ongoing integration of the real estate department. An analogy might be provided by another adviser to the corporation: the investment banker who assists the company in restructuring the ownership structure of a business unit or division, to reflect a change in corporate strategy. Like the mergers and acquisitions specialist, real estate/financial advisers need to be equally familiar with the investor market, technical structuring issues and the client. Corporate officials responsible for the transaction -- including representatives from the finance department and the business units that use the facilities -- should expect a fully integrated approach to a sale-leaseback or any other real estate-related transaction involving facilities that are integral to the company's present and future business operations.

At present, advisers typically use specialists in investment sales, finance or real estate consulting to review different parts of an assignment. Rather than fostering an integrated approach to the transaction, this structure will usually accentuate the divide that exists between two service providers or even separate areas within the same organization. As a result, the sale-leaseback transaction tends to fall between the cracks, lacking a natural home. To be successful with the corporate client the adviser needs to be equally familiar with commercial real estate markets, corporate financial analysis and reporting, accounting rules, and the specifics of their clients' industry and business.

Opportunities for service providers As corporate management adopts new methods for managing their business and increasing shareholder value, the opportunity exists for real estate service providers to participate in this process. Strategic transactions like a net lease for new construction or a sale-leaseback of an existing facility are two ways that the service provider can work with the real estate department and contribute to the ongoing integration of the department into the larger organization. For example, part of the process may include looking at the impact of a transaction on debt covenants and key financial ratios. Changes in these ratios can affect the company's credit profile. Also, the sale-leaseback can improve a leverage ratio such as debt to equity or an interest coverage ratio such as cashflow from operations to interest expense through the reduction in debt levels.

Equally familiar with the company's business strategy and investor parameters, the adviser will be able to utilize accounting, tax and financial expertise to provide relevant analysis to the client. At this point, the service provider has gone from being an "order taker" to a trusted adviser.

The new model is built on a foundation of client-service provider dialog and allows for the natural alignment of corporate real estate transactions with investors. The company may want to restrict the number of investors seeing the transaction on a confidential basis or it may want to canvas a large pool of investors. Much like a private placement, it allows more input into the transaction on the part of the client. This enhances the relationship between service provider and client and allows the client to see the clear value brought to the transaction by the real estate/financial adviser. The process will be successful if in the corporation's final assessment there is a seamless transition through the due diligence, analysis and marketing phases of the transaction, and the transaction complements its overall corporate strategy.

Stephen F. Olsen, senior vice president at Jones Lang Wootton USA, specializes in capital markets activities on behalf of domestic and international corporations.

* Create sale proceeds that can be reinvested in higher-yielding areas of business * Improve bottom line by structuring a transaction with an operating lease with below-market or flat rental payments * Allow company to maintain control and management of strategic facilities

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