Trend Tracker_DWM

Volume 11, Issue 5 - June 2010

Trend Tracker

Using Sale-Leasebacks as a Financing Tool
by Michael Collins

Many door and window companies are having difficulty attracting capital in the current business environment. Often, such companies look to real estate sale-leaseback transactions as an alternate source of financing. In a sale-leaseback, a company sells its real estate to a group of investors who, in turn, lease the property back to the company. In this way, the company is able to receive the cash generated by the sale of the company and still maintain uninterrupted use of the facility on a ten- to 20-year lease.

Sale-leaseback transactions of industrial real estate have become more common over the years because of a groundswell of investors willing to invest in industrial property. First Industrial Realty Trust estimates that 60 percent of all industrial space, roughly 15 billion square feet, is owned by the corporations that occupy it. This represents roughly $700 to $900 billion invested in non-core assets.

Mechanics of a Sale-Leaseback
The liquidity created in a sale-leaseback is a function of a number of factors, including the appraised real estate value, as well as prevailing lease rates in the area. A capitalization rate determined by the market is applied to the annual lease payment to determine the total proceeds. For example, one million square feet of space leased at $2 per square foot would generate $2 million per year in lease payments. Applying a capitalization rate of ten to that payment would yield $20 million in proceeds.

Sale-leaseback investors, meanwhile, increasingly view candidate companies from a private equity perspective, rather than a strictly real estate perspective. In other words, they carefully assess the strength of the company, the way it goes to market, its place in its industry and its ability to pay the lease payments for a long period of time.

"One-million square feet of space leased at $2 per square footwould generate $2 million per year in lease payments. "

Drawbacks of Sale-Leaseback Transactions
In the last 18 months, the pricing on sale-leaseback deals has been soft because a number of investors have left the market. Some are tending to ailing real estate portfolios, while others have retreated because of the dearth of debt financing. Like merger and acquisition transactions, sale-leaseback transactions peaked in 2007, the most recent year during which debt financing was relatively plentiful. However, new real estate funds are continually being formed.

Assuming that a company’s owners are satisfied with the pricing the market places on their real estate, the successful completion of the sale-leaseback will result in a significant lease expense where there was none previously. Depending on the use of the funds generated, it is likely that the company will have greater financing related expenses after the transaction, at least for the short term. Finally, a sale-leaseback does not free a company from certain real estate-related expenses. Under a triple-net lease, the lessee (seller) still is responsible for repairs and maintenance.

As the market begins to recover, many door and window companies will find that their trailing losses prevent them from securing traditional debt or equity financing. A sale-leaseback gives a company the flexibility of freeing up capital without ever speaking to a lender. It is likely that many land-rich door and window manufacturers will explore this financing option in the next two years. This will be particularly true for companies located in areas that did not experience a significant run-up in commercial real estate prices and, therefore, haven’t suffered as much of a price decline. For such companies, a sale-leaseback could be the perfect vehicle to fund their growth in the coming recovery.

Michael Collins is vice president of the building products group at Jordan, Knauff & Company, an investment banking firm that specializes in the door and window industry. He may be reached at mcollins@jordanknauff.com. His opinions are solely his own and not necessarily those of this magazine.