Real estate strategy

Corporations that own their buildings
might find it advantageous to lease
back their real estate holdings. By deploying a sale-leaseback strategy, capital
tied up in real estate can be redirected
toward an entity’s core business.

The current investment climate makes
this strategy particularly attractive, given
the high demand for corporate real estate.
“The outlook for corporate real estate,
especially properties leased by credit tenants on a long-term basis, looks extremely good now and for the foreseeable
future,” says Keith Yearout, a senior associate, investment properties for CB
Richard Ellis.

Smart Business spoke with Yearout
about sale-leaseback transactions, how
companies can benefit from such an
arrangement and why the environment for
leasing back commercial properties is so
favorable right now.

How does the practice of leasing back real
estate holdings work?

A sale-leaseback transaction entails the
sale of corporate real estate and the simultaneous commitment to a long-term lease,
generally 10 years or longer. This strategy
allows a company to redeploy the capital
that had been tied up in ‘sticks and bricks’
into the core business. You effectively control the property after the sale, and can
even retain the right to buy back the property at a pre-agreed price.

How can a company benefit from such an
arrangement?

The biggest benefit of a sale-leaseback
transaction is the ability to increase a company’s financial flexibility by offloading
real estate at attractive price levels and
redeploying the proceeds into its core business to yield a higher rate of return than it
would otherwise get from owning its real
estate.

Another advantage of a sale-leaseback
transaction is that it improves the balance sheet by reducing the negative
impact of depreciation and interest on
your income statement. It also provides off-balance sheet financing, hedges
against obsolesence, and may help you
avoid or reduce tax liability.

What considerations should be taken into
account when deciding if this is a viable
strategy?

In determining if a sale-leaseback strategy makes financial sense, a company needs
to ask itself the question, ‘Is our corporate
rate of return on our core business greater
than the yield we get from owning our real
estate?’

Due to functional obsolesence, most
commercial buildings depreciate in value
over time so the sale-leaseback strategy
makes sense for many companies —
though it’s not without risk.

One potential pitfall includes the possible forced relocation at the end of the
initial lease term. At the end of a lease
without any renewal options, a tenant
may be forced to either negotiate an
extension at current market rates or
relocate. To prevent such a situation, a
company should consider employing a
long-term lease or ensuring that the initial lease agreement includes renewal
options that allow the tenant to renew at
pre-determined rates.

What are the first steps that should be taken
if a company decides to lease back its real
estate?

Once a company decides to explore a
sale-leaseback transaction, the first step
should be to request a disposition proposal
including an ‘opinion of value’ from a commercial broker who specializes in the sale
of income-producing real estate. My team
at CBRE provides this service free of
charge, and the proposal includes a
detailed sale-leaseback vs. own analysis.
This helps the company to determine if it
makes sense to continue to own its real
estate or invest capital back into the core
business.

In addition to engaging a qualified commercial broker, a company should also
consult its tax adviser to make sure that
any potential tax liabilities generated from
the transaction are fully considered. It is
possible to defer a considerable portion of
the tax liability, and having a tax adviser on
the team with specific knowledge in this
area is very beneficial.

How does the current investment environment look for corporate real estate?

We are experiencing an unprecedented
amount of liquidity in the investment real
estate market resulting in record high
prices for corporate real estate. Investors
seeking income-producing vehicles are
being drawn to corporate real estate due
to its ability to provide superior returns
compared to treasury bills, municipal
bonds, corporate bonds and other income-oriented investments including certificates
of deposit. With baby boomers nearing
retirement age over the coming years,
more investors are shifting from capital
accumulation mode and reallocating into
income-producing investments. As a
result, we currently have more capital
chasing corporate real estate than we
have product available.

KEITH YEAROUT is a senior associate, investment properties
for CB Richard Ellis. Reach him at (513) 369-1334 or
[email protected].