The pace of property transactions in the US began to slow months before September 11, but the dealmaking ground to a halt after the attacks. Now, uncertainty about new terrorist threats, the war in Afghanistan and a recession have kept most buyers, sellers and developers sidelined. There is one exception, however. Net lease financiers are busier than ever.
"We've had years where we've seen 18 to 20 per cent returns in a bear market," said William Polk Carey, founder of WPCarey, a New York-based investment banking firm that specialises in net lease financing - also called sale-leaseback. "And it feels like we're entering one of those again." In an economic downturn, businesses come to firms such as WP Carey because they need to raise cash, often to cut debt. As equity investors and bank lenders grow more skittish, companies, particularly those with low credit ratings, can no longer afford the risk premiums demanded by those sources.
Offloading non-core assets, such as real estate, seems to be the logical next step. So, a company sells its office complex or its portfolio of retail spaces to an investor and signs a long-term lease - 10 years at the very minimum - to rent the property.
Aside from an immediate influx of cash, the company moves the slowly appreciating property asset off its balance sheet, eliminating a drag on earnings. Properties usually return 8 to 12 per cent a year, while a listed company may want 20 to 30 per cent gains. Meanwhile, the buyer acquires a stable asset and a guaranteed tenant.
Sale-leaseback deals have been part of the US property market for more than 30 years. Only 30 per cent of US corporate real estate is owner-occupied, according to PwC, compared with 60 per cent in Europe.
But European corporations are catching on. British Telecommunications sold £2.3 billion sterling of its properties last year. France Telecom recently announced it would sell between €2 billion and €3 billion of its real estate assets to cut debt, and Marks and Spencer has completed the sale and leaseback of 78 stores.
Retailers have been the most frequent users of net lease financing in recent years because their businesses are dependent on expanding into new stores but outright ownership means tying up much-needed cash. Companies with industrial and office properties did use sale-leasebacks during mergers and acquisitions, but they were not as worried about moving properties off their balance sheets, particularly in the boom years of the late 1990s, when profits and share prices were soaring and capital was readily available.
"Through 1997 and 1998 it was hard because we had to compete with corporate debt and equity," said Gordon DuGan, president and chief acquisitions officer of WP Carey. "There were enormous amounts of capital. Half of our transactions were with companies we had already done business with." But in the first half of 2001, the pool of money available to the average company dropped by about 70 per cent, according to industry estimates. Companies from a variety of sectors began making net lease inquiries, and new investors entered the market. G E Capital, the finance arm of General Electric, for example, started a sale-leaseback programme in January.
WP Carey counts GE Capital and Lexington Corporate Properties Trust, which is based in New York and invests in single-user properties, as two leading competitors.
There are downsides to sale-leasebacks, however. Companies may find they can be more flexible with a property they own than lease.
Also, Moody's Investor Services, the credit ratings agency, recently warned that telecommunications companies such as BT an d France Telecom, which have sold property to cut debt, could have credit downgraded as a result.
"We repeatedly get questions from creditors of the companies that are engaging in this kind of transaction as to whether they should be concerned," said Carlos Winzer, senior vice president at Moody's.
"The answer is, if used extensively, they should. These transactions often involve some of the company's best assets." If the proceeds from a sale-leaseback were used to finance a 20 to 40 per cent reduction in debt, Moody's said it would probably lower the company's rating by one notch.
Furthermore, credit matters. Although net lease financiers might agree to a sale-leaseback with a low-rated tenant to purchase a higher-quality property, most prefer to deal with premier tenants.
GE Capital, for example, requires a BB rating or higher.
WP Carey is an exception. Although it deals with blue-chip tenants, the bulk of its transactions are with sub-investment grade and private companies. "If we can get a good risk-adjusted return, we'll go anywhere to get it," including into Asia and the emerging markets, said Edward LaPuma, executive director.
"We don't look to any rating to get comfort, we look to the expertise of our people."
As the number of participants in the net lease market increases, deals may get more intricate and competition more intense. For now, sale-leaseback specialists have a lucrative niche.
WP Carey, for example, has nearly tripled its deal volume from 1997 to 2000, and it invests in less than 2 per cent of the proposals that come across its table.
