One common consideration among firms considering unlocking capital through sale leaseback financing is, “with higher interest rates today, should I be cautious about locking in a relatively fixed rate if interest rates may fall in the future?”
With the current macro backdrop, this is a natural question to ask. However, items for firms to keep in mind when making this decision include A) The capital stack will need to be filled, if not from a sale leaseback, from elsewhere (at likely more challenging terms) B) the benefit of proceeds today likely trumps proceeds tomorrow C) “Higher for longer” may in fact be the new normal and D) the absence of a near term maturity wall for a sale leaseback provides benefits compared to traditional debt solutions.
Filling the Capital Stack
Corporates and private equity firms exploring a sale leaseback generally find themselves evaluating the alternative amongst a host of other capital solutions. The cost of these alternatives (e.g. traditional debt, mezzanine debt, mortgage financing, just to name a few) has increased substantially.
While many of these costs of capital have risen >400 bps over the recent timeframe, comparatively speaking, sale leaseback capital has risen more moderately, providing for a more attractive cost of capital today.
Proceeds Today Trump Proceeds Tomorrow
Would it make more sense to defer the capital raise until a more favorable interest rate environment arrives? Generally speaking, the value that a growth investment brings today outweighs any perceived benefit to a deferral period.
In many cases, firms are looking for capital to put to use for opportunistic growth scenarios, e.g. to acquire a business, to install a new production line, develop new products, etc. In today’s competitive environment, there is generally a narrow window to execute on those opportunities. For example, the M&A target may go away. Other competitors may make headway if a production line installation is delayed.
The value of that capital today (capital that is sitting on the balance sheet in the form of real estate) is worth more utilized today to execute on growth opportunities, than deferred for a number of years.
Higher for Longer?
While the main focus of many has been the Fed’s primary goal to fight post-COVID inflation amid resilient economic figures, there are a good number of structural elements that underly this battle, which have gained less attention. A number of these include deflationary pressures which we have taken for granted and are now beginning to abate, including outsourcing labor strikes and the green transition.
The common trend towards outsourcing over the last 20-30 years provided natural deflationary effects. A common first page in corporate and private equity execution toolkits has included the evaluation of opportunities to move production to lower cost countries to boost margins. However, COVID-era supply chain dislocation, as well as penalizing tariffs over recent years have caused these same parties to re-think that element. In fact, more groups are looking to “in-source” post-acquisition, either acquiring domestic firms specifically for their production facilities, or aiming to vertically integrate domestically.
Labor strikes have gained momentum, the most recent example of that being an unprecedented auto-strike across three automakers at the same time (General Motors, Ford and Stellantis). The ask is for 36% raises over four years and a traditional defined-benefit pension plan for workers hired after 2007.
The likely green energy transition will also have its impact. In addition to the costs of satisfying green tape, there are steep costs that will need to be incurred to build infrastructure, repurpose production lines and re-skill, among other considerations, all contributing to an inflationary environment at the margins.
Benefit of No Maturity Wall
Lastly, in a “higher for longer” environment, one further benefit a long term sale leaseback provides is the relative absence of a maturity wall, as compared to traditional debt items. A 5 to 7 year term of traditional debt instruments introduces refinancing risk, distraction and more frequent intermediary fees, which is not relevant given the long term nature of the sale leaseback.
Summary
It is unlikely that interest rates decrease materially in the near future. The sale leaseback provides many benefits, including capital today at a relatively attractive cost, which can be used to fund organic and inorganic growth initiatives, as well as serve as an efficient long-term capital solution.