Liquid Bricks

With many banks continuing their cautious ways -- about 40 percent of respondents to the Federal Reserve's Senior Loan Office Opinion Survey from April had tightened credit standards; none had eased them -- treasurers and other financial execs are looking at a range of financing options. One that's getting attention is sale-leaseback transactions.

As the term suggests, with a sale-leaseback, a company sells a property to an investor, which could be an investment fund, a real estate investment trust (REIT), or an individual, and gains the proceeds. The company then agrees to make ongoing lease payments and continues operating in the facility.

While the volume of commercial real estate transactions overall is down, the ratio of sale-leaseback deals has increased, reports Real Capital Analytics, a real estate research firm. Sale-leasebacks through May of this year accounted for 8.6 percent of all commercial real estate sales of $5 million and up. This compares with 7.3 percent for all of 2008 and is the highest percentage in the past 9 years, says Jessica Ruderman, senior market analyst with RCA.

Sale-leasebacks also are being used by more midmarket companies, says David Steinwedell, senior partner with AIC Ventures, a provider of alternative financing solutions, including sale leasebacks, for midmarket firms. Many businesses view the deals as a way to free up cash, says Steinwedell. "Companies can earn more dollars on their business than their real estate."

"Our philosophy is that we don't want to tie up our capital in our buildings," says Terry Braatz, treasurer with $1.6 billion Actuant Corporation, a provider of hydraulic and electrical tools and supplies, as well as motion control systems and other products. "We use sale-leasebacks as an opportunistic financing tool." In January 2008, Actuant completed a sale-leaseback, totaling about $10 million, on three manufacturing facilities in Illinois, Iowa, and Pennsylvania.

Actuant had picked up the properties via acquisitions it had completed several years earlier. When the company ends up with real estate as part of an acquisition, and if it's clear that Actuant will use the property on a long-term basis, management then decides whether it to sell it and lease it back. For industrial real estate, Braatz says, the "sweet spot" in leaseback terms is at least about 10 years. Shorter time periods scare off investors, who don't want to be continually finding new tenants. Actuant also tries to package several properties within one transaction. "You have a broader investor universe if the size is bigger," Braatz says.

Braatz noted that the environment for completing all real estate deals, including sale-leasebacks, "is a little more challenging," today. This is a result of both less investor capital and uncertain real estate values.

Talking About Sale-Leasebacks

As a result, more discussions than sale-leaseback deals actually are taking place, says Gerald Levin, senior managing director with Mesirow Financial, a Chicago-based financial services firm. Behind the disconnect, he says, is the difficulty that potential buyers have in finding lenders willing to support deals of about $50 million or more. "Big deals are very hard to do because no one source of financing is comfortable committing more than about $30 million." The sale-leasebacks that are taking place are with strong, investment-grade credits, he adds.

Moreover, some potential sellers haven't accepted the drop in commercial real estate prices, Levin notes. This has prompted some to hold on to their properties until the market bounces back.

Languishing real estate prices affect the sale-leaseback market in other ways, says Ben Harris, managing director and head of U.S. investments with W.P. Carey & Co. LLC. Until a couple of years ago, "the sale-leaseback market had been a significant recipient of 1031 exchange capital." A 1031 exchange, named for a section of the tax code, allows an investor who sells a real estate holding and reinvests the proceeds in another investment property to defer any capital gains tax hit. With real estate values falling, there's less need for sellers to defer tax hits. "It's a high-class problem that people don't have to worry about now," Harris says.