Briefly, a sale leaseback transaction occurs when an owner and user of the same property decides to sell the property while maintaining the use of the property through a lease. Essentially the transaction provides more liquidity to the business owner as equity requirements of a refinance are freed up. A seller/lessee (tenant) looking to build does not have to tie up cash in the form of a down payment required by conventional banks. A seller/lessee who already owns the property can unlock the equity in the real estate and turn that equity into cash. For a corporation the added benefits include improved debt-to-equity, current , and return-on-assets-ratios when structured properly.
The dynamics of the current real estate environment set up well for these type of transactions:
Fundamental valuations are low: Appraisers should be using discounts of 30 to 40% over 2007 peaks with further to go if they are using recent comparables and assessing fundamentals in arriving at their valuations. Why does this matter to the user? It matters because valuations are not going to come back expediently and assets with leases are valued differently than vacant assets.
Credit is tight: The fact is that the terms are much tighter than in the recent past, and somewhat tighter than historical norms as a reaction to the credit crisis. This means Loan to Value Ratios are lower and proceeds from refinancing will be lower on top of the lower valuations banks will get from appraisers.
Investors still chase yield: Valuing a lease based on the yield to the investor as opposed to fundamental metrics will yield the seller/lessee much more than they would receive on a fundamental real estate valuation.
Interest rates are low (but for how long): Interest rates are as low as they can go yet recent comments by Fed official Thomas Hoenig (see WSJ article here) suggest that they will not wait too long to begin raising interest rates. We know that rates cannot go lower, so when they do start to rise valuations will be impacted in sale/leaseback transactions due to investors yield requirements going up as well.
To understand the implications of the above consider the following example. A 50,000 office building that was appraised in 2007 for $10M and refinanced then at an 80% LTV would have yielded $8M to the owner. That same building today will appraise for $7M and only be provided a 65% LTV yielding $4,555,000. The asset will still be on the books at book value and artificially deflate Return on Assets.
By contrast, the business can sell the asset for closer to the appraised value and lease it back under a triple net lease. If structured properly, the company will net more cash and be able to have similar occupancy costs, thereby enhancing return on assets, and freeing up capital to put to use in its core business.
2010 will be a good year for sale leaseback transactions to occur for companies looking to free up liquidity, reduce liability, and enhance long term operating performance.
Postscript: As a case in point Novant Health recently completed a $122 million sale-leaseback of a 22-building medical office portfolio in Winston-Salem and Charlotte, N.C.
