This article was first published in REACT News on July 16, 2020 and is available for subscribers here.
Corporates are looking for ways to generate cash amidst the pandemic.
Restrictions by governments all over the world to limit the spread of COVID-19 have affected all businesses to varying degrees. Whilst specific sectors have performed well many non-essential businesses have seen significant drops in footfall and revenue.
Given the lack of cash flow it is important to understand one's ability to utilise assets as an alternative source of finance to bank debt. One possible avenue for businesses owning real estate assets is by entering into a sale-and-leaseback.
They enable companies to free up the capital needed to run the business and save on the displacement and relocation costs of moving to new rented accommodation. This form of capital raising is attractive because it may have tax advantages and unlike a loan, it does not increase a company's debt load.
Sale-and-leasebacks have become increasingly popular. In 2019 nearly £2.5bn of commercial real estate deals were sale-and-leaseback transactions, which equated to almost 10% of total UK volumes.
Sale-and-leasebacks can be attractive to both successful and struggling businesses. Struggling businesses can use a sale-and-leaseback arrangement to release cash to fund working capital or debt obligations whilst opportunistic companies could invest in growth.
Finding the right structure
There is significant investor appetite for long-leased assets let to strong covenants which is evidenced by pension funds' activity in the sale-and-leaseback market but it is vital that the sale-and-leaseback structure is designed in such a way that creates a return for the purchaser and maximises the value to the vendor whilst also providing flexibility.
Common sale-and-leaseback structures include:
- Occupational leasebacks: Where the vendor takes a rack rented lease for a term subject to a rent review. Rent reviews can be open market, fixed uplift or index linked. Repurchase leasebacks: Where the vendor takes a lease for a term with an option or an obligation to repurchase the asset at the lease expiry.
- Geared leasebacks: Where the vendor pays a ground rent and a percentage of rents from under-letting for a lease term subject to a review.
- Portfolio leasebacks: The structures outlined above covering multiple properties.
Private equity's growing presence in the market has led to more complex deal structures whereby rents and yields are hedged against financial derivatives. The yield required by investors is not only predicated on the structure of the sale-and-leaseback but also depends on the covenant strength of the tenant, legal tenure, operational cost liabilities and the terms of any buyback or sale rights. Yields are usually keen as they offer the purchaser a guaranteed tenant for a defined period of time.
When entering into a sale-and-leaseback it is important to seek independent professional advice to ensure the structure, rent and returns profile are equitable and maximise value to all parties involved in the transaction. It is also important to consider the business and tax implications as well as the other risks inherent in this type of arrangement.
