Property – to lease or not to lease? This is the question being asked around an increasing number of board tables. Companies are eyeing off balance sheet property assets against new capital for core business activities.
According to leading industrial property brokers, Epping Property, International Research has shown that the best option is usually to sell existing property assets. Then lease back the same building or new premises.
“The opportunity lost from not actively using the cash tied up in property, outweigh most benefits of direct property ownership by corporate organisations. Although the basic debate between direct ownership and leasing has always been around, with some indication of a cultural bias toward ownership, the past couple of years has brought the issue more sharply into focus.”
According to Epping Property, higher expectations by shareholders and equity partners meant many companies were coming under greater scrutiny. “Companies don’t have the luxury of being able to produce average returns in today’s market. Shareholders expect much more than that these days and the attitudes of directors have also changed. On an ongoing basis, the reinvestment of that money into the core business of the company is usually going to have enormous current benefits.”
“In most cases, the decision boiled down to a basic equation,” says Epping Property. “If you are a retailer or manufacturer and you usually have about a 25 percent return on your funds from the retail or manufacture business, why would you have money tied up in property? The returns will likely not be substantial enough.”
“One of the main arguments given by companies for their decision to own a property rather than lease is because it offers greater control over the site and therefore greater flexibility to use the property in the manner it wanted.”
“However, from a physical or operational view,” advises Epping Property, “it makes little difference if the company was the legal owner or the tenant of the property. Furthermore, experience has shown time and again that where the lessee is a reliable company, the value of its rental covenant is itself sufficient to place the company in a position of strength when it comes to dealing with the owner.”
“This is an increasing trend with scores of firms raising large sums of cash without visiting the stock or debt markets. They are only selling their office and manufacturing properties and then leasing back space. Sale and leasebacks, as the transactions are called, aren’t a new concept, but they have picked up speed over the past months, as companies perceive the real-estate cycle to be near its peak.”
“The trend has gained steam of late for several reasons. For one, publicly traded businesses in all industries are under pressure by investors to shed non-core assets and focus on their main businesses. Also, massive layoffs and big mergers in the past few years have left many companies with lots of excess space. We see organisations from the largest listed companies to private businesses using this as a financial vehicle. From the company’s side, it’s the pressure to continue to increase earnings,” says Epping Property.
“Of course, dwindling property prices are also driving companies to consider getting their property off their books. Many of the companies certainly feel that by selling they are exiting an asset that is not performing too well and reallocating the funds into channels where returns are better or more definable.”
“One of our philosophies,” says Epping Property, “is that if you’re not in the real-estate business, in most cases, you shouldn’t own property. Sale and leasebacks typically make a company’s balance sheet more attractive by increasing the return-on-asset figure that number analysts or bankers consider when making their share or business recommendations. Analysts usually don’t give much weight to owned real-estate assets in evaluating companies, because such assets are seen as illiquid.
On the other side of the equation, buyers traditionally have a longer-term outlook and benefit because rental rates will rise in time across the country, so they can lock in healthy leases that will provide substantial returns for several years.
An example of a good leaseback done quite a few years ago, is Mpact. Click here to view the property.
Epping Property concludes that what distinguishes a smart sale-lease-back transaction from a dumb one all depends on what a company does with the cash raised from the sale of the real estate. “Companies that redirect the money into a prudent acquisition or some other fast-growing investment, or who use it to lower debt, will benefit from sale-leaseback transactions.