Sale-Leaseback, A Hidden Treasure Chest?

American companies, including smaller, family-owned businesses and Corporate America, own an estimated $4.1 trillion of non-specialized "investable" real estate. Yet historical returns from equity investments have consistently exceeded those of real estate. As a general rule, any dollar that can be "monetized" or sourced from the sale of corporate real estate and reinvested in that company's listed or unlisted equity stock would create positive leverage.

That's why any business owner or CFO whose company owns real estate should review or consider a sale-leaseback transaction.

What is Sale-Leaseback?
Although used for more than 50 years, sale-leaseback transactions – and the benefits they can offer to corporate investors – are still not always fully understood.

In it simplest form, a sale-leaseback transaction entails the sale of corporate real estate and the simultaneous commitment to a long-term lease, generally 15 years or longer. This combination allows a company to redeploy the capital that had been invested in real estate into the core business.

Why is it worthwhile?
The biggest benefit of a sale-leaseback transaction is the ability to increase a company's financial flexibility by off-loading real estate at attractive long-term rates, while maintaining the availability of bank financing for a future date. By being both the lessee and the seller of the property, a corporation has greater bargaining power to ensure it maintains uninterrupted control of the facilities, including operations, maintenance and alterations, it negotiates the rights to assign and sublet the facilities, as well as enjoys lengthy initial and renewal terms.

What's the catch?
While sale-leaseback can be a worthwhile strategy for many companies, it is not without risk. Some of the risks to consider are:

Loss of residual property value
In most cases, the future value of any single-tenant property will be lower than today's sale price since real property generally depreciates over time. In the unlikely event that the residual value of the property increases over the primary lease term, the potential rental income from the property will increase as well. By negotiating a renewal option past the primary term at fixed rents, the seller/lessee can enjoy rental costs that are below market while still benefiting from greater potential sublease income.

Possible Relocation
At the end of a lease without any renewal options, a seller may be forced to either negotiate an extension at current market rents or relocate. To prevent such a situation in a sale-leaseback transaction, a company should consider employing a long-term (50-60 years) lease, thereby delaying the need to relocate or renegotiate until the asset will likely have become obsolete. When the term comes due, the buyer/lessor almost always would allow renewal of the lease, and on a worst case basis, at the same price the seller/lessee would pay for alternative space.

High Rental Payment
Rental payments under the lease cannot be adjusted without the consent of the lessor. As a result, if the rental market softens, a seller/lessee may be locked into a rate higher than the market rate. Yet, the company has protected itself from a decrease in property value and still enjoys the use of the capital. In addition, a decrease in rental rates represents a good opportunity to renegotiate the lease at a lower, modified rental rate for a new primary term.

Specific Accounting Principles
While the fundamental accounting principles of sale-leasebacks are relatively simple, following the generally accepted accounting principles (GAAP) provisions are critical. Failure to comply may result in the re-characterization of a sale-leaseback transaction as a mere financing vehicle, depriving the parties of the very benefits they have sought to achieve.

Can Sale-Leaseback Add Financial Value?

Will it strengthen company financials or enhance shareholder wealth? Can sale-leaseback pay down debt, reduce risks, increase working capital, or fund acquisitions by executing sale-leaseback?

Basic diagnosis can show financial impact analysis, blended cost of capital and other potential transaction terms/conditions, analysis of impacted balance sheet, efficiency, liquidity, & risk ratios,

To take further steps and diagnose your own opportunity click here

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May June 2015 Market Observations

The US equity markets continue their advance 

• The S&P 500 returned 1.3% for the month. Small cap led the advance. 

• Growth outperformed value in the small and large cap segments. Value outperformed growth in the mid cap segment. 

• Health care and technology were the top performing sectors in the small, mid and large cap segments, supporting the growth indices. The energy sector was the worst performing sector with negative returns, dragging down the value indices. 

• Real assets such as MLPs, REITs and infrastructure were negative performers for the month. 

• Price momentum and Growth factors were the best performing. Quality and value factors were weaker but still positive. 

Weak performance in international and emerging markets for the month 

• International equities, as reflected by the MSCI EAFE Index, finished the month with a return of -0.5% in USD terms, underperforming the US market. Japan outperformed Europe as per the MSCI Japan Index return of 5.0% versus the MSCI Europe Index which returned -0.8% in USD terms. 

• Emerging markets, as reflected by MSCI EM Index, returned -4.0% for the month in USD terms. EM Eastern Europe and Latin America were the worst performing EM regions. 

• The energy sector was the weakest performing in both non-US developed and emerging markets. 

• Price momentum was clearly the top performing factor in developed markets. Quality was the top performing factor in emerging markets. The weakest performing factors were value in both developed and emerging markets. 

High yield credit was lone bright spot in fixed income 

• High yield credit was the best performing fixed income segment for the month. Only high yield, leveraged loans and short duration Treasuries posted positive returns (with the exception of CCC-rated credit, which was slightly down for the month). 

• Long duration Treasuries was the worst performing fixed income segment followed by investment grade credit. 

• Most major currencies depreciated relative to the US dollar during the month. The main exception was the Renminbi. 

• Currency depreciation hurt the performance of non-dollar bonds after a strong month in April.

Market information source: Bloomberg.

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Clicking the Like button on various social media platforms, such as LinkedIn, Facebook, etc. does not constitute a testimonial for or endorsement of Redmount Capital Partners LLC or any Investment Advisor Representative. “Like” is not meant in the traditional sense. Posts must refrain from recommending investment advisory services or providing testimonials for our firm, since they are strictly prohibited. Please understand that we are required to delete such posts, since this is a regulatory requirement.

Are high-yield bonds and floating-rate loans at risk?

The constant pursuit of yield in this low interest rate environment might have pushed the demand for high-yield bonds and floating-rate loans high enough to impact judgement of banks underwriting and backing new issues.

Banks are frantically underwriting high-yield bonds and financing syndicated floating-rate loans, counting on investors to absorb everything coming to markets.

Interest rates for new bond and loan issues have dropped, prompting borrowers do more acquisitions, buybacks. etc.

Private equity fund operators are some of the largest biggest users of high-yield bonds to arrange leveraged and management buyouts. Floating-rate loans are used in buyout deals as well.

Low interest rates, willingness of banks to underwrite bonds and loans, and readiness of investors to acquire bonds and invest in loans have pushed mergers & acquisitions and buyout activities to new highs. Valuations of companies being snapped up in auction style sales are breaking records after records, reminiscent of 2007.

The illustration to the left, a deal tombstone published in the Dow Jones Private Equity News, speaks to it. In this case, a large private equity and LBO operator borrowed $1.75 billion to supplements its own funds to acquire more companies. Keep in mind that acquisitions are done by issuing high-yield bonds, to add to the equity. As such, banks are lending loans to add to the equity of the buyer, all while still lending more via high-yield bonds. More leverage to execute more purchases. All loans and bonds will end up in investor accounts, through mutual funds and ETFs, in a very short order.

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Clicking the Like button on various social media platforms, such as LinkedIn, Facebook, etc. does not constitute a testimonial for or endorsement of Redmount Capital Partners LLC or any Investment Advisor Representative. “Like” is not meant in the traditional sense. Posts must refrain from recommending investment advisory services or providing testimonials for our firm, since they are strictly prohibited. Please understand that we are required to delete such posts, since this is a regulatory requirement.