Corporate debt maturities are approaching at an inconvenient time in the capital markets for portfolio company borrowers. Inflation, GDP growth expectations, and the actions of the Federal Reserve have served to decrease available leverage and increase borrowing costs. In addition, corporate lenders are more selective and some require borrowers to agree to restrictive covenants. This has pushed chief financial officers of many operating companies to find new sources of capital for their companies. Increasingly, sale-leasebacks are being utilized to fill gaps in the capital structure.
Commercial real estate is not immune to the challenges affecting the capital markets, including high interest rates, high borrowing costs, and higher amortization—but sale-leasebacks still generate full proceeds for sellers at attractive rates. According to Gordon Whiting, managing director and head of net lease real estate at Angelo Gordon, the time is now for companies to explore sale-leasebacks. He noted two main considerations when exploring a sale-leaseback in the current market.
A Cure for a Tough Market
The Fed’s pursuit of higher interest rates can wreak havoc on a company’s cash flow. In addition, overall economic conditions are putting strains on businesses at a time when obtaining financing for operating improvements or capital expansions has become more difficult.
“The cost of financing for companies has gone up, and that is driving interest in sale-leasebacks,” Whiting says. Under a sale-leaseback, a company that owns property sells the building to an investor, and that investor leases the property back to the company on a long-term basis – generally 20 years or more.
The strategy is a cross between a real property sale and a corporate financing arrangement but is completed at cap rates that are well below corporate lending rates. A company can unlock property assets on their balance sheet and generate cash to invest into their business for anything, including new product development, expansions, or any other initiative to grow revenue and profits. Because the arrangements are long-term, a company maintains access to their critical facilities. Additionally, all the lease payments are considered operating expenses, providing tax advantages for lessees.
“It can be a great tool for a CFO to raise capital,” Whiting says.
The Time is Now for Sellers
Companies in many industries—including retail, manufacturing, cold storage, distribution, and medical office—are using sale-leasebacks more frequently than they had been. Whiting reminds any company considering a sale-leaseback to keep in mind that, in today’s environment, the clock may be ticking.
“Potential sellers are realizing that if they are going to sell a property, their real estate may be more valuable today than it will be tomorrow,” says Whiting. “Also, sellers are facing economic uncertainty over the next couple of years and higher interest rates, so capital may be more expensive in the future.”
On a positive note, both buyers and sellers are looking to close deals quickly. In order to sweeten a potential close, Whiting also suggests looking at an entire real estate portfolio to see if there are multiple properties appropriate for sale-leaseback. “As a seller, you’re generally getting better pricing and more interest if you have multiple properties,” he says. And a larger payout.