While advising the chief financial officer of a major European retailer recently, Cushman & Wakefield’s head of occupier strategy for EMEA, Matthew Stone, discovered that 60% of the retailer’s capital was tied up in real estate that was generating only a 6% return, whereas the firm’s core business was delivering returns of up to 26%. “A company’s shareholder capital should be deployed in the most profitable part of that business, which is logical but rarely practiced,” says Mr Stone....


Holding real estate on a company balance sheet like this is not the most efficient way of creating shareholder equity – something which most firms have become acutely aware as the current economic downturn takes its toll. Companies, particularly those in the financial services sector, will need to access capital in 2009 as credit markets continue to contract. “Sale and leaseback was definitely a trend pre-credit crunch but it is becoming even more of one, post-credit crunch,” says Mr Stone.

A method that banks have been using for some time to release capital is redeploying real estate value into their core business through sale and leaseback transactions. And outside the banking sector, more multinational companies have also started to look at selling their real estate assets as a way of raising much-needed capital, says Mr Stone. According to Cushman & Wakefield data, the European real estate market was valued at $346bn in 2007, of which $79bn was sale and leaseback transactions. Although the credit crunch significantly shrunk total market transactions to $169bn in 2008, the proportion of sale and leasebacks increased to reach $54bn. “There are not many parts of our business which have increased in the past year, for obvious reasons, but sale and leaseback is one of the them,” says Mr Stone.

Commercial space

In the US, corporations lease about 90% of the commercial space they occupy; in the UK that figure is 70%, and in continental Europe it is only about 30%. But that dynamic has been changing, says Mr Stone, who sees huge potential for sale and leasebacks in Europe.

Anecdotally, Cushman & Wakefield is seeing an increasing number of organisations enquiring about the financial implications of doing sale and leasebacks, particularly in the financial services sector – not surprising for a sector in which the top 43 banks in Europe collectively have $83bn of land and buildings on their balance sheets. Merrill Lynch estimates that European banks require an additional $94bn to shore up their capital, so unlocking the value of real estate could be a potential antidote to the financial sector’s unravelling. Spanish banks BBVA and Banco Sabadell and Belgian bank Fortis are all involved in selling major property portfolios.

As sale and leaseback is creating more leasing activity, there are more innovative ways in carrying out the process, says Mr Stone. “When Boots, the UK chemist, structured a leaseback of 312 of its UK branches a couple of years ago, it embedded a number of break options and flexibility which the company would never have got away with if it had gone out and leased shops from a lot of different landlords,” says Mr Stone.

In the past, raising the biggest amount of capital was not the one and only reason companies would do a sale and leaseback. For example, electronics giant Sony used sale and leaseback to restructure its business. Sony only leased back, by floor area, 55% of the 185,000 square metres it sold because its business operating model had changed, therefore it did not need the extra space.

The head of telecommunications firm Nokia Siemens Network’s (NSN’s) real estate programme management Bob Canavan says that sale and leaseback has been common practice at NSN since its formation in April 2007. For NSN, the credit market turmoil is not a driver for the practice of sale and leaseback. “In many ways, for us, it is a natural development of our activities towards a more streamlined portfolio, post-merger,” he says.

However, for most companies, the process is less about innovative deal making or business restructuring, and increasingly becoming a matter of survival as the current economic downturn and a dearth of credit drives the sale and leaseback practice forward. Pre-credit crunch, raising corporate debt and the cost of a sale and leaseback was about the same, according to Mr Stone. “Now that the cost of equity and corporate debt have gone up significantly and even though corporate real estate values have gone down about 30% in the past 18 months, the relative cost of raising money through selling real estate has gone down, not up,” he says.

Cash-rich companies

But it is more difficult to convince cash-rich companies such as Microsoft of the benefits of sale and leaseback. Nigel Baker, senior director for EMEA real estate and facilities at Microsoft, is looking at opportunities to acquire freehold interests rather than taking the sale and leaseback route, because a sale and leaseback will only unlock the maximum capital potential in a buoyant market. “Anyone that does a sale and leaseback in this market must be desperate,” he says.

Mr Baker has not needed to do sale and leasebacks in Europe, the Middle East and Africa because Microsoft’s liquidity is good. Like many US companies, Microsoft’s interests across the area are predominantly leasehold. There are exceptions to this rule and much depends on how critical real estate is to a firm’s business. “For example, a 10-year lease on a data centre site is a risky strategy because of the high infrastructure costs of moving it if the lease is terminated,” says Mr Baker.

In a company such as Microsoft, savings in real estate would not significantly affect business margins; but although Mr Baker cannot affect the share price of the company, he is in a position to create a good environment for the company’s employees. In this case the impact of real estate on the bottom line is felt though creating a work setting which attracts high quality staff.

Microsoft owns the real estate on which it has its Redmond, California, flagship campus in the US. Many major US corporations own their headquarters as a matter of corporate pride. But when a market is in crisis the emotional attachment to flagship real estate becomes more measured, as in the case of General Motors, which is looking to sell its corporate headquarters building in Detroit.

The US car manufacturer has fallen on hard times and as well as selling off parts of its business, the firm is looking for buyers for its Detroit skyscraper, the Renaissance Centre. It was reported in November last year that the firm asked real estate adviser Jones Lang LaSalle to help raise $257m from the sale and leaseback of some of its European offices. However, the biggest prize will be for the firm’s Detroit global headquarters, which speculators have said could raise about $500m.

Winners and losers

In every crisis there are winners and losers. International bank HSBC has benefited from the commercial property slump by buying back its corporate headquarter building for $369m from Spanish property company Metrovacesa. HSBC sold the Canary Wharf skyscraper in London to Metrovacesa in summer 2007 for $1.61bn – using debt provided by HSBC. Now in trouble, Metrovacesa was forced into a sale and leaseback of the tower in December after failing to refinance the deal elsewhere or find another buyer.

Just as a desperate homeowner facing eviction is vulnerable to sale and leaseback exploitation, so too is a troubled business. Companies facing capital shortfalls increasingly need to be wary of negotiating the right lease terms at the point of sale. UK retailer Woolworths went into receivership at the end of 2008 and industry analysts have blamed the sale and leaseback of its 182 stores as the key cause of its demise.

Although the company was selling $2.5bn of goods when it went into administration, it had accumulated a huge $591m-worth of debt. In 2001, the firm de-merged from retail group Kingfisher, at the same time selling and leasing back its real estate portfolio in return for $901m. Under the terms of the contract leases, which guaranteed the new landlords a rising income stream, Woolworths’ rent is said to have increased from £70m ($99.9m) a decade ago to £160m.

KPMG property veteran Michael Lindsay says the sale and leaseback market has gradually become more landlord-friendly as the market has weakened, and companies must be aware of the impact of the lease terms they are signing up to. “In the good-old, bad-old days one could get away with buy-back options and the lessee would often joint venture with the investor,” says Mr Lindsay, who remarks that a joint-venture sale and leaseback today is almost impossible. “The market is now dominated by institutional purchasers who are a lot less flexible than companies such as Topland and Consensus, the leveraged players of the past. The market is now dominated by the likes of Prudential and Canada Life, who have very big annuity funds, and of course pension funds, all of which prefer to own the asset fully,” he says. For Mr Lindsay, the biggest change in the sale and leaseback market has been a move away from leveraged investors where the leverage in the sale and leaseback could be anywhere from 75% to 90% to essentially un-leveraged equity investors: the institutions.

Potential pitfalls

There are obvious potential pitfalls of doing a sale and leaseback, says Mr Lindsay, which include the inevitable loss of flexibility relative to outright ownership. “Flexibility to vacate is and has always been relatively limited but there is still some flexibility on what can be done to the property, how it is redeveloped, extended, sub-let,” he says, while remaining positive about the benefits of sale and leaseback overall as a means of unlocking capital.