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An Ideal Climate for Sale-Leasebacks

When RF Micro Devices sought financing to grow its business late last year, a sale-leaseback proved to be a convenient financing alternative. The company, which manufactures computer chips for cellular phones, had been suffering a stretch of declining revenues that limited its financing options.

By selling its 100,000 sq. ft. headquarters building to Miami-based United Trust Fund (UTF) and then leasing back the property via a 15-year, triple-net lease, the company was able to reinvest the sale proceeds in its manufacturing business. “They're a good company in a bad market,” says Fred Berliner, senior vice president and director of acquisitions at United Trust Fund.

A slowly recovering economy and strict lending and accounting standards for synthetic leases have created a perfect breeding ground for sale-leasebacks. Demand for the transactions as an alternative source of capital is picking up at the nation's biggest sale-leaseback firms.

“We do well when the economy's doing well, and we do great when the economy's not doing well,” says Gordon Whiting, an executive director at W.P. Carey. The New York-based company completed $1 billion in sale-leaseback transactions in 2002, a whopping 153% increase from $395 million in 2001. This year, Whiting says the company is poised to surpass its record-breaking total of 2002.

As the economy continues to sputter, more companies are faced with dwindling profits and rising debt. Although they may be unable to obtain financing from banks or through public offerings, companies starved for cash can have better luck arranging sale-leasebacks of their real estate holdings. It then can use the cash to reduce debt or fund business growth.

In a sale-leaseback transaction, a company sells property to an investor and then leases it back, typically in a long-term, triple-net lease of 15 to 20 years. In a triple-net lease, the tenant is responsible for paying taxes, maintenance fees and insurance costs.

“What you see today is a tremendous demand for funds,” says Berliner. “You previously had a host of companies that could raise money via the equity and stock markets. That's all dried up for the lower echelon of companies.” UTF completed $274 million in transactions in 2002, up from $212 million in 2001. Berliner says the company will do about $350 million in business this year.

Improving the Bottom Line

Companies with below-investment-grade credit are a major source of business for sale-leaseback specialists. Today, the ranks of those companies are growing. UTF generates about half of its business with sub-investment-grade clients and the other half with investment-grade companies.

“We turned down a lot of deals last year,” says Berliner. “Companies can have a bad year or two, but we want a company whose prospects are good.” For UTF to consider doing business with a customer, the company must be well-established and on track to generate steady revenues.

Demand also is brisk from investment-grade companies, says Berliner. In the second quarter of this year, UTF purchased an 800,000 sq. ft. distribution facility from women's clothing designer Jones Apparel Group, which decided to abandon the business of owning real estate.

W.P. Carey specializes in transactions with companies that are below investment grade. The company has had no difficulty lining up business with its core client base, but Whiting says the company also is doing business with a growing number of investment-grade companies.

“Companies realize they're going to get a higher return if they take the money out of a building and invest it,” says Whiting. Manufacturing companies often use sale-leasebacks to fund improvements at their factories. That was the strategy of Polar Plastics, which sold its headquarters and manufacturing center to W.P. Carey and leased it back in a 20-year, triple-net lease.

The Favored Financing Option

Companies that want to opt out of synthetic leases also provide business to sale-leaseback companies, although volumes have yet to reach the flood-like levels some experts predicted. Corporate America flocked to this financing method in the mid-1990s because it allowed companies to enjoy the tax benefits of ownership without listing depreciation expenses on their balance sheets.

In a synthetic lease, a company sets up a special purpose entity (SPE) to hold title to its property and then leases back the property. But the deals require leasees to make balloon payments at the end of the lease, and the tenant assumes all the liabilities of ownership. New requirements from the Financial Accounting Standards Board (FASB), spurred by the accounting fraud that sank Enron, now require SPEs to be listed on a company's balance sheet.

Although Whiting says a growing number of companies are turning to sale-leasebacks after their synthetic leases expire, UTF is still waiting for a boost from the synthetic lease market. “It hasn't been as much as we expected,” says Berliner. “Hopefully it will come this year and next year.”

Steve Webb is a Jacksonville, Fla.-based writer.

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