Friday, February 6, 2009

Sale Leasebacks: 2009's Catch-22

Some companies like to own their own real estate. Some refuse as a matter of business principle. There are numerous advantages to both, but ultimately the decision boils down to this: Would I rather not pay rent at the cost of being illiquid and having a liability on my balance sheet, or free up working capital for my business at the cost of paying rent?

Of course the answer to that question, as any trained economist would tell you, is it depends. It depends on the type of business, the size of the business, the philosophy of the business, and the financial strength of the business. When traditional means of access to capital dwindle as we have seen happen in the economy as a whole, that last "it depends" becomes of vital importance to most companies.

While the volume of sale-leaseback transactions dropped off the face of the earth in the fourth quarter of 2008 as did the velocity of all types of real estate transactions, we would be remiss to suggest that is a trend.

While many private real estate investors are unlikely to sell voluntarily in 2009 due to rising CAP rates and declining prices, corporate real estate owners aren't making decisions based on internal rates of return, CAP rates, or typical hold periods, but rather what will be in the best interests of the company. And in this environment, most companies are sorely in need of cash to grow operations and in some cases to even make payroll.

So is there opportunity for investors to capitalize on the economic swoon of corporate real estate? Well, sorry to go all economist on you again, but yes and no. Yes, there will be opportunity, and we will see a rise in sale leaseback transactions in 2009. However, most likely will not occur until the second half of the year due both to economic uncertainty for many companies, and the bureaucracy with which such a process is undertaken, with decisions being made on multiple levels and flowing through what can be a disjointed chain of command.
That being said, when these deals do hit the market, at attractive CAP rates nonetheless, investors will have to keep one thing in mind. What exactly am I buying, and is this really a good deal? Sure, the real estate is good real estate, and the price is right, but if its a single tenant deal, what's my downside protection should my new tenant report poor earnings this quarter? Will their credit rating decrease? Are they going to be financially solvent for the term of the lease? After all, if they were in such good shape, why would they need to sell me their asset?

Our guess is that, while the size, scope and return on these investments will vary largely on a case by case basis, the strength of these deals will lie not just in the strength of the tenant, but the profile of the new landlord. A well-capitalized, but straight yield buyer may have to rely more on luck than a developer with a relatively low hurdle rate. At one time, developers could never compete for deals like this cause there was little value to add and CAP rates were too low. Now however, stable returns will be higher, and should the tenant go bankrupt, the developer would have the wherewithal to reposition the asset more quickly and efficiently.

One thing we can steadfastly tell you without wavering? Caveat Emptor.

No comments: