A sale and leaseback transaction enables a company to mobilize latent reserves and support the implementation of its operational strategy.
Corporate real estate as an opportunity to overcome the crisis
Each company is affected by the COVID-19 pandemic. However, depending on its line of business, its pre-crisis financial situation or even its clients, the effects of the crisis could vary extremely. While for some, the crisis will only constitute a temporary decline in their activity, for others, it is their viability itself that will be at stake due to a possible lack of liquidity and cash flow problems despite the support measures granted to companies by the Confederation or the Cantons.
If companies have several operational levers to face the crisis, those who own their operating property also have significant latent reserves. The mobilization of these reserves could facilitate the implementation of the company’s operational strategy, such as generating cash, investing in production tools, financing an acquisition (external growth), deleveraging or even paying dividends.
In the current low interest rates universe, investment property prices are at their highest. Indeed, the inflow of capital on the market and the quest for secure returns are pushing investors to invest in this asset class, characterized by an attractive risk / return ratio compared to government bonds or equity markets. Thus, in response to the COVID-19 crisis, it could be appropriate for companies to carry out real estate sales, to free up cash and take advantage of favorable market conditions.
Whether it be a defensive or an offensive strategy, real estate outsourcing, usually called "Sale & Leaseback", is a solution which consists in simultaneously passing from the status of owner to that of tenant of the premises.
From a structural point of view, the core business of a company is generally more profitable than a property. Indeed, a company's EBITDA margin is generally higher than real estate yields that could be negotiated for occupied assets, whether it be offices, light industrial, warehouses or even retail surfaces. In addition, given the current valuation of real estate, the growth potential in terms of operating assets value should be limited in the medium term. Therefore, the current period, so singular, could be the ideal time to engage in a Sale & Leaseback operation.
The mobilization of financial reserves through a Sale & Leaseback operation is all the more interesting given that the market value of a property is generally undervalued in the companies’ financial statements due to the accounting standards (recognition at acquisition cost / depreciated construction cost). This is all the more true when a building has been recorded in the accounts for a long time.
Between singularity and complexity
Although apparently simple, a Sale & Leaseback operation is quite complex and requires, among other things, appropriate internal and external communication, a tax or even legal analysis and significant real estate skills.
Firstly, it is necessary to define the potential rent, the expected sale price and the duration of the lease. The higher the rent and the longer the lease duration, the higher the sale price will be. However, if the expected rent is too high, the company’s going concern may be at risk, while a lease that is too long can limit its future flexibility. Conversely, for an investor, a lease that is too short or a rent that is not in line with the market rent can be an obstacle. A real estate appraisal taking into account the various envisaged scenarios is the best solution to define those parameters. In practice, it is important to consider that during an outsourcing operation, the company sells both its real estate and its own signature (which the investor will consider as the creditworthiness of its tenant).
In addition to the “major lease clauses” and the sale price, it is essential that the company anticipates its future needs and the consequences of a sale when preparing the lease contract or the sale purchase agreement. All the aspects which will allow it to retain sufficient control over its premises will have to be negotiated and set out in contracts. By way of illustration, it may be interesting to include a pre-emptive right in the sale purchase agreement or to define the renewal conditions in the lease. More complex strategies, such as the establishment of framework conditions for a future extension or the creation of a ground lease could also be relevant.
At an international level, Sale & Leaseback transactions are commonly carried out on the basis of triple net leases. The new owner is thus relieved of all charges (taxes, insurance and maintenance costs). Swiss tenancy law stipulates that at least the taxes and the building insurance are borne by the owner.