There are many reasons for businesses both large and small to monetize owned facilities. Sale leasebacks can be a fantastic capital allocation tool — whether the rationale is improving the company’s cost of capital, funding internal growth, capitalizing on a real estate value arbitrage, helping fund an M&A transaction or simply looking to de-lever.
Generally speaking, companies consider sale leasebacks to address a number of strategic or financial drivers, or a combination of both. Many operating businesses own one or more of their facilities, whether they are retail stores, manufacturing facilities, distribution centers or their corporate headquarters, to name a few examples.
Before diving into the rationale for selling one’s owned facilities, perhaps it is first instructive to consider why operating businesses would want to own real estate at the outset. The most common reasons we hear are control and optionality. Said differently, controlling the subject property for an extended period of time is important to the company so that it can control use, alterations, and cost of occupancy. Owning also provides flexibility to close the facility should circumstances in the future change dramatically.
Non-core facilities, stores etc. with little operational importance or a short-term useful life would likely not be a worthwhile candidate for a sale leaseback. While short-term SLBs can make sense in certain situations, generally a meaningful driver of value is the long-term lease that the selling business enters into. Selling tenants also retain long-term operational control over the property as a tenant through the lease structure and renewal options, largely mitigating control concerns when a sale leaseback is executed.
Turning to the many reasons a business would consider a sale leaseback…
Focus on Core Competency. Businesses generally exist to produce goods or services, not to own real estate. Whether you are a maker of widgets or seller of coffee, the building you are in is likely very important. However, being the owner of that property is not generally the optimal corporate financing strategy from a capital allocation perspective.
Redeployment of Capital. Freeing up capital from owned real estate can be a great way to fund both internal and external growth. Real estate sitting on the balance sheet is effectively a low return asset, and SLB proceeds can be reinvested back into the business at typically far greater rates of return. Think 7 – 9% unlevered returns on real estate vs double digit returns from further business investment.
Managing Stakeholders. Management teams answer in many cases to a board of directors and ultimately to investors, whether they are public shareholders, private equity investors, or other family members. Why tie up low return assets when sale leasebacks often (1) capture immediate value creation and (2) free up capital to be better used elsewhere. This concept is especially true when a business is valued at a lower multiple than the effective real estate multiple.
Preparing for a Business Sale. Ahead of sale it almost always makes sense to evaluate (or re-evaluate, as the case may be), a company’s owned facilities. Sometimes in an M&A transaction it is best to convey owned real estate along with the operating business. But other times it clearly creates more value to separate out owned facilities and sell to a real estate investor. Always remember real estate investors are the natural fit for facility ownership, and often pay higher multiples for the real estate than the underlying business is worth… which effectively enables a company to maximize the combined operating business and real estate value.
Eliminate Residual Risk. Real estate is a risk asset, albeit a relatively low return risk asset. Why own and deal with the risk of obsolescence, or maybe more importantly the opportunity cost of not harvesting value while real property is near all-time high valuations.
Value Arbitrage. When there is a meaningful delta between a company’s EBITDA multiple and the effective real estate multiple, a sale leaseback is an attractive tool to capture immediate value creation. Sale leaseback cap rates commonly imply multiples of 12x – 16x. Realizing that multiple by pursuing a real estate monetization will result in immediate value creation when the business multiple is lower than the effective real estate multiple.
M&A Acquisition Financing. There is occasionally an opportunity for a business acquiror to utilize sale leaseback proceeds to help finance an acquisition. In this case we would run a concurrent SLB and the owned real estate would potentially decrease the acquiror’s equity check and thereby boost returns. This can be important to both financial and strategic acquirors as it can effectively ‘buy down’ the acquisition multiple.
Cost of Capital. Owned real estate often represents an efficient and attractive cost of capital for a corporation. When considering a sale leaseback relative to other corporate capital sources, the appropriate point of comparison is the cost of financing versus the company’s weighted average cost of capital (WACC). If the WACC is greater than the sale leaseback cost, then the owned real estate is in theory less expensive to sell than it is to keep on the balance sheet.
In discussing this point with many businesses over the years, we have found that many people tend to think about the sale leaseback cost relative to a company’s debt cost of capital. However, given that a real estate monetization is a sale of 100% of the capital stack of that particular asset, the appropriate point of comparison is against the WACC.
Capital Management. A sale leaseback can strengthen credit metrics and overall company capitalization, and can be utilized to retire maturing debt. Say for instance a $100 million EBITDA business is levered at 3.5x net debt / EBITDA, and is able to execute a sale leaseback on $75 million of facilities and use proceeds to de-lever. Post-sale leaseback net debt / EBITDA would be reduced below 3.0x.
We always find the topic of whether to consider a sale leaseback to an interesting discussion to have. While an SLB is not always the optimal capital allocation decision, there are many strategic and financial drivers that can make it a compelling capital alternative. If you have an applicable situation in mind, we would be delighted to discuss these ideas with you in greater detail. Please feel free to contact us to discuss your specific situation.