For companies that hold their operational real estate on their own balance sheet or through related party entities, be it retail stores, manufacturing plants, or surgery centers, real estate ownership is not the core business. Sale leasebacks (“SLBs”) can be a highly attractive capital allocation tool with many strategic and financial drivers to consider (see our Insight). When businesses make the decision to pursue a sale leaseback, the question of execution becomes an important one. Each sale leaseback situation is unique and can draw from a number of different buyer pools.
The dramatic collapse of yields around the world in fixed income markets since the Global Financial Crisis (“GFC”) has caused institutional investors to allocate more capital to yield generating assets. Among the most popular allocations for defined benefit plans has been income generating real estate. This has set the stage for an active sale leaseback market with ample capital allocated to the strategy, on the part of both debt and equity investors. After a pandemic-induced pause followed by a stock price resurgence among NL REITs over the last four quarters, NL REITs have continued their acquisition spree in Q1’21 with many of them looking to deploy hundreds of millions of dollars in sale leaseback closings. Generally speaking, the largest NL REITs trading at the highest FFO multiples have continued to grow, led by Realty Income with $2.3 billion of acquisitions in 2020 and its recent announced merger with VEREIT.
This Insight reviews the main categories of sale leaseback investors.
Figure 1: Types of Sale Leaseback Buyers
|Net Lease Real Estate Investment Trusts*||Dedicated Sale Leaseback Private Equity Funds||Generalist Institutional Real Estate Investors||Private Buyers|
|Cost of Capital||IRR and Cash on Cash Model||IRR and Cash on Cash Model||IRR and Cash on Cash Model|
Public Real Estate Investment Trusts (REITs)
In the U.S., Public REITs are investment vehicles traded on a stock exchange (most often the NYSE) that pool investor capital in order to own and manage commercial real estate, and also, increasingly other hard assets such as infrastructure. REITs are structured as tax advantaged entities that must distribute a high proportion of their rental income, making them popular dividend vehicles for individuals as well as for defined benefit plans. In the U.S., public REITs own approximately 20% of all U.S. institutional quality real estate1, which has been growing continually since the GFC. In most sectors outside of retail, U.S. REITs have been net purchasers of real estate over the last 10 years. This has been supported by widespread capital availability from new issuance of common stock and unsecured bonds.
Figure 2: Public REIT Capital Raising2
In each of the past 10 years, U.S. REITS have acquired more than $50 billion per year3. Capital raising has exceeded this to fund refinancing, development, and other non-acquisition uses. One of the highest growth subsectors in the REIT space has been the group focused on net lease investing.
Figure 3: Net Lease REIT Universe
|REIT||Ticker||Market Cap ($000s)||Enterprise Value ($000s)||Dividend Yield|
|W P Carey & Co.||WPC||13,347||19,640||5.6%|
|National Retail Properties||NNN||7,887||11,230||4.7%|
|Spirit Realty Capital||SRC||5,297||8,113||5.5%|
|Agree Realty Corporation||ADC||4,427||5,786||3.7%|
|Broadstone Net Lease||BNL||3,131||4,883||4.8%|
|Lexington Realty Trust||LXP||3,538||4,882||NA|
|Global Net Lease||GNL||1,816||3,853||8.4%|
|Essential Properties Realty Trust||EPRT||2,901||3,800||4.0%|
|Four Corners Property Trust||FCPT||2,095||2,871||4.7%|
|One Liberty Properties||OLP||519||948||7.2%|
|Alpine Income Property Trust||PINE||143||286||5.3%|
As of 5/27/2021
The net lease REIT universe in the table includes only traditional asset class properties like retail, office, and industrial (excludes healthcare, gaming, and other specialty properties). Most of the actively investing REITs in the sector trade above Net Asset Value, which allows these REITs to utilize lower leverage than private buyers and still achieve return hurdles.
The net lease REIT sector’s relatively high valuation in the public markets has given them an attractive cost of capital in competition against other buyer types. Over the last 4 years, of the 15 equity REITs that have gone public through IPOs, 9 were net lease REITs of various sectors whose primary business plan revolved around delivering a steady dividend to investors without a management intensive infrastructure.
Figure 4: Recent REIT Initial Public Offerings5
|Name||Property Selector||IPO Date||Size ($mm)|
|Broadstone Net Lease, Inc.||NNN||Sep-20||$655|
|Netstreit Corporation||NNN – Retail||Aug-20||259|
|Alpine Income Property Trust, Inc.||NNN||Nov-19||164|
|Postal Realty Trust, Inc.||Specialty||May-19||88|
|Essential Properties Realty Trust, Inc.||NNN||Jun-18||523|
|VICI Properties Inc. NNN – Gaming||NNN – Gaming||Jan-18||1,392|
|Americold Realty Trust Industrial||Industrial||Jan-18||794|
|Industrial Logistics Properties Trust Industrial||Industrial||Jan-18||552|
|Safety, Income and Growth, Inc.||NNN – Ground Lease||Jun-17||236|
|Plymouth Industrial REIT, Inc. Industrial||Industrial||Jun-17||63|
|Clipper Realty Inc. Residential||Residential||Feb-17||88|
|Invitation Homes Inc. Residential||Residential||Jan-17||1,771|
|Innovative Industrial Properties, Inc.||NNN – Specialty||Dec-16||77|
|MedEquities Realty Trust, Inc.||NNN – Health Care||Sep-16||275|
|Global Medical REIT, Inc.||NNN||Jun-16||130|
Net lease REITs comprised 9 of the 15 recent REIT IPOs, accounting for 53% of capital raised. Of the 9 NNN REIT IPOs, all (except for Alpine Income) have been able to access the market through multiple follow-on equity offerings utilizing proceeds to continue their acquisition growth.
Most of the recent batch of net lease REIT IPOs are active participants in the sale leaseback market in their respective asset classes. Their access to readily available capital generally provides sellers in a sale leaseback transaction greater certainty of execution.
Sale Leaseback – Economics for REITs
For net lease REITs, growth in distributable income per share is achieved through accretive acquisitions of new properties. This point is key to understanding how and why REITs are so acquisitive.
Figure 5: Net Lease REIT – Sale Leaseback Economics
|Equity Mkt Cap||$2,000.0|
|Total Mkt Cap||$3,350.0|
|% Funded by Debt||40%||80.0|
|REIT – Acquisition Accretion|
|Existing Portfolio||Acquisition||Pro Forma|
|Pref Interest Expense||(7.0)||(7.0)|
|FFO / Share||$1.78||$1.81|
Figure 5 illustrates a REIT with a ~$3 billion + portfolio that is trading at a 20% premium to NAV. For this hypothetical REIT, purchasing additional assets even with low leverage can be significantly accretive. In this illustration, a $200mm acquisition can increase FFO per share by ~2% and therefore potentially increase the dividend by up to 2%. Net lease REITs have been some of the most consistent growth vehicles in the REIT universe, employing this external growth model.
Private Equity Real Estate Overview
Similar to REIT investment, private equity real estate has been supported by strong inflows of capital searching for current yield. According to Preqin, during the first quarter of 2021, private equity real estate funds raised a total of $33.2 billion. Most of these funds were raised by the largest and most established fund managers such as Oaktree, Cerberus, Ares, and BlackRock.
Figure 6: Real Estate Private Equity Fund Raising5
(as of March 31, 2021)
Figure 7. Q1 2021 Largest Private Equity Capital Funds Raised8
|Fund||Capital Raised ($B)|
|Oaktree Real Estate Opportunities Fund VIII||4.7|
|IPI Data Center Partners II||3.8|
|Cerberus Institutional Real Estate Partners V||2.8|
|NREP Nordic Strategies Fund IV||2.3|
|Areas US Real Estate Opportunity Fund III||1.7|
|Waterton Residential Property Venture XIV||1.5|
|BlackRock Asia Property Fund V||1.2|
|Signal Alpha II Fund||1.1|
|GreenOak Europe Secured Lending Fund II||1.0|
|Atalaya Asset Income Fund V||1.0|
While sale leaseback real estate investors make up a small portion of the total raised, they represent a substantial group of investors that overlaps between general real estate funds and dedicated sale leaseback groups.
Figure 8: A Sampling of the Active Real Estate Private Equity Funds with a Sale Leaseback Focus
|Multi-Disciplinary Private Equity Firm||Multiple commingled funds focused on various asset classes|
|Northeast Real Estate Private Equity Firm||NY based Real Estate Private Equity firm. $10b+ AUM. Value added focus. Has dedicated SLB arm|
|Dedicated SLB Private Equity Firm||Real Estate Firm solely focused on real estate sale leasebacks. Has dedicated funding line, able to close all cash. Very credit focused|
|Northeast Multi-Strategy Private Equity Firm||Dedicated Real Estate Fund associated with multidiscipline Private Equity Manager|
|Dedicated SLB Private Equity Firm||U.S. and Europe based Real Estate Private Equity Firm. $3.5b portfolio. 3rd Commingled fund w/ institutional partners|
These sale leaseback groups are competitive with the REITs in execution certainty as they too have committed, dedicated capital, including commingled funds as well as lines of credit that can bridge to permanent financing after closing.
As a group, the private equity firms are competitive in pricing as well partly due to utilization of property level leverage. Up until the outbreak of COVID 19, private equity sale leaseback investors were able to secure high loan- to-value property level mortgages with attractive terms, compensating for their relatively more costly equity capital compared to REITs.
Recently, several broadly focused real estate private equity firms have seen an opportunity in the net lease space and have allocated their capital to companies and/or strategies focused on this sector. In May 2021, Carlyle Group agreed to provide up to $300 million in growth capital to Four Springs Capital Trust, a private REIT focused on single-tenant, income-producing properties. In April 2020, Brookfield Asset Management Inc. committed $500 million of equity to Fundamental Income, a private REIT targeting single-tenant assets net leased to businesses operating in industries that directly and indirectly serve the US consumer.
Figure 9: REIT and Sale Leaseback-Focused Private Equity Firm Cost of Capital Comparison
Cost of Capital Comparison
|Assumptions||Public Traded REIT||Real Estate Private Equity|
|Leverage||35% – 45%||70% – 75%|
|Cost of Leverage||2.5% – 4.0%||3.0% – 4.0%|
|Equity||55% – 65%||25% – 30%|
|Cost of Equity||8% – 10%||14% – 18%|
|Resulting WACC||6.1% – 7.4%||5.8% – 8.2%|
Illustrative comparison between Real Estate PE firm utilizing higher leverage vs. a publicly traded REIT with lower leverage. REIT’s cost of equity is based on 15 – 20x FFO multiple with 3% annualized growth vs. a PE firm that has a mid-teens cost of equity. For strong sponsors such as the private equity firms, debt continues to be available for new transactions where the seller of the real estate has maintained profitability.
Other Institutional Real Estate Investors
A third group of real estate investors are oftentimes viable partners in a sale leaseback transaction. As previously referenced, capital allocation into income producing real estate continues to be strong. There are a wide range of institutional investors such as private equity funds, fund-less sponsor-like companies that manage real estate by leveraging their expertise utilizing third party institutional capital, developers, regional real estate firms, non-net lease publicly traded REITs (i.e. healthcare, industrial and office) and other private investors.
Many from this wide swath of commercial real estate investors do not have the same business plan as dedicated net lease investors. Depending on its characteristics, however, a sale leaseback can overlap with the investment parameters of a large portion of these other institutional real estate investors.
Looking to a few examples, for a well-located industrial facility near a medium to large city, the majority of potential offers would likely draw from a broad group of buyer types. The rent from the sale leaseback would provide an attractive current income. An investor would view the downside risk of the tenant leaving, while not ideal, as a potential opportunity for a value-add conversion to capitalize on robust demand for warehousing space. In this instance, the bids from generalist real estate investors can potentially be more attractive than those from dedicated sale leaseback investors, depending on a variety of factors including the quality of the location and the building, and the credit of the tenant.
For a single tenant office building in a large or growing market, there would also be significant interest from non-dedicated sale leaseback investors. There are often investors that already own properties in a given market seeking to augment their ownership and drive potential future synergies in leasing and management.
There are also dedicated specialty asset investors that focus on varying types of commercial real estate, who would be likely investors for sale leasebacks in their respective sectors. For example, corporate data centers spun out in sale leasebacks are often acquired by public or private data centers REITs or PE firms that have the operational expertise to manage those facilities as multi-tenant properties. Healthcare REITs are always adding to their relationship ecosystems by entering into sale leasebacks with the aim of making follow-on investments with that tenant as they grow.
The large universe of real estate investors that do not focus exclusively on sale leasebacks represent a vast pool of potential partners for owner-operators. Each sale leaseback situation is unique, and with that the buyer pool can vary greatly depending on the opportunity.
Private Buyers (i.e. Individuals and Small Family Offices)
While private buyers comprise the majority of real estate investors in the U.S., they are generally not as active in the sale leaseback market as the institutional buyer set. Most private buyers are not frequent participants in the market given the price point of most sale leaseback transactions. Many private buyers are only in the acquisition market once every few years. For passive investors not looking to deal with tenants, maintenance and other management issues, net lease properties leased to well-known names are the most favored investment choice. Dollar stores, drug stores, quick service restaurants, banks, gas stations & convenience stores are popular choices amongst this investor group. Due to investor demand, many of these types of properties command extremely low cap rates. A well-known fast-food restaurant with 20 years of term can price around a 4% cap rate.
While willing to pay aggressive cap rates for well-known credit tenants, private investors tend to be less active in sale leasebacks. In the sale leaseback market, the transaction size if often larger than what a private investor is able to commit to a single transaction. A fast-food restaurant with a $2 million price point is much more attainable to purchase than a $7 million manufacturing or healthcare facility. Many private buyers are also dependent on debt financing, making them less appropriate in instances where a sale leaseback is utilized in an M&A situation as lenders may not be able to quickly underwrite, diligence and fund a loan under the timelines required. Lastly, the credit concentration for an investor can be a hurdle, particularly for mission critical facilities leased to profitable but below investment grade tenants.
Due to the continued fund raising from all corners of the real estate industry, real estate owner-operators that wish to access the sale leaseback market have an abundance of options in choosing an investor. In addition to the large REITs and dedicated sale leaseback private equity funds with a direct calling effort to source opportunities, there is a vast number of other real estate investors that can potentially provide an attractive transaction for an owner. By working with an advisor, real estate owners can access these other investors not only to optimize the terms and execution of their sale leaseback transaction, but also to secure the best real estate partner for the long term.
3 BofA Securities – BofA’s 2Q20 Wall of Capital Monitor
6 SLB Capital Advisors