On the very first day I started working in the sale-leaseback business, more than 15 years ago, my father walked into my office and handed me two documents. "Read these," he said. The first was a two page net lease he negotiated with The Southland Corporation (now 7-Eleven, Inc.) from 1963. The second was a recently negotiated 67 page net lease for the purchase and leaseback of a free-standing supermarket. His point was well taken. It was clear times have changed. If you want to awaken the sleeping giant, you must be prepared.

There is approximately $3 trillion worth of real estate currently owned by companies, and that figure is rapidly shrinking. This real estate may be a corner drug store or a corporate campus of office buildings. It may be a biotech laboratory or a prison. Corporate America' diverse business interests require a diversity of real estate types to meet their changing needs. While over the years having the right location has remained a constant for Corporate America, owning the location has not. The preferred method for obtaining a low cost of capital for the majority of Corporate America is the sale-leaseback. While sale-leasebacks have a long history, it is an enigmatic phenomenon that today, sale-leasebacks are being completed at an unprecedented rate. The sale-leaseback has evolved from an obscure method for a company to realize the potential of a typically ignored asset to a multi-billion dollar industry.

Each and every company-owned property has value above and beyond its actual use. That value is capital which can be accessed via a sale-leaseback. A properly structured sale-leaseback enables Corporate America to enhance their balance sheet, expand market share, realize tax and accounting benefits, improve earnings and provide capital for investment opportunities along with many other beneficial uses.

Credit vs. Real Estate

In the world of sale-leasebacks, you are more likely to starve than have the opportunity to have your cake and eat it too, if you are waiting for an investment grade tenant willing to pay rent on a Worth Avenue, Rodeo Drive or Fifth Avenue location. These transactions are sparse. Corporate America builds their buildings wherever it is appropriate and sometimes appropriate is in a major CBD or where the cows graze. It all depends on the type of business being conducted and the type of real estate required.

If IBM approached us to do a sale-leaseback on an iceberg, we would probably do it. The point is, for the appropriate credit, the real estate becomes a secondary consideration. Conversely, for the appropriate real estate, even a dubious credit can be palatable. It is simply a question of return and risk. There are two schools of thought. With an investment grade credit, an investor almost always receives a lower return than with a sub-investment grade or unrated company, however, with an investment grade tenant, there exists inherent value because of the certainty of payment over a long term lease. The upside potential, however, is usually limited by fixed rentals and options. Less risk, less reward.

However, the majority of companies are not investment grade. They are either sub-investment grade or not rated at all. The due diligence process, therefore, must be aggressively pursued with particular consideration to the real estate. There is more risk because of the level of certainty for obtaining the rent payments over the long term is not the same. However, a safety net can be provided with a good real estate location. If the property has been purchased knowing that the real estate could easily be re-leased or converted to an alternate use, perhaps even at higher rents, is the higher return then worth the risk? Both credit and real estate are important factors in the analysis of a sale-leaseback and that importance differs from investor to investor as evidenced by the vast secondary market for net leased investments. Credit and real estate, while important aspects of a sale-leaseback, are merely the starting places in the underwriting of a sale-leaseback transaction.

Paul Domb is vice president, asset management of United Trust Fund in Miami.

©2001 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.