Improving MOIC and IRR via sale and leaseback
The same building can be worth two different amounts depending on who owns it. Sitting inside a portfolio company, it is included at the buyout multiple applied to the EBITDA it supports. Sold to a real estate investor and leased back, it is priced on a yield (the inverse of a multiple) reflecting the income profile. The sale and leaseback multiple is often materially higher than the multiple applied to the operating business. This gap is where sponsors can create value and enhance returns.
A summary of sale and leaseback as a tool for value creation
Real estate held inside a portfolio company is typically carried on the balance sheet at book value, or occasionally fair value. Both are usually lower than the proceeds deliverable through a sale and leaseback.
A buyout investor pays a multiple reflecting growth, cyclicality and execution risk of the operating business. This includes the real estate which is often not assessed on a standalone basis and limited value is attributed to it. A sale and leaseback is valued by the investment market on a yield (the inverse of a multiple) driven by the secured, long-term income stream attached. The arbitrage exists because two markets are pricing the same asset differently.
For more detail, please see Capcore’s article ‘Sale and leaseback as a tool for value creation’.
The effect on MOIC
Below is an illustrative example of value creation via sale and leaseback:
The following table shows the increased MOIC delivered by a sale and leaseback, using the same illustrative example and assuming a sponsor’s equity cheque of £40m:
The £15.0m of equity value created increases MOIC by approximately 0.4x. The proceeds raised can then be deployed elsewhere in the business to create further value and boost sponsor return metrics. The uplift is a function of the spread between the two multiples. The actual arbitrage varies for each property and is subject to real estate, credit and lease structuring considerations. The arbitrage is usually largest for stable, asset-heavy, cash-generative businesses in industrial, logistics, manufacturing and consumer and it narrows for high-growth, high-multiple businesses.
The effect on IRR
Sale and leaseback can positively impact IRR in several ways. Sponsors which utilise a sale and leaseback to fund the acquisition of the business itself can reduce the amount of equity needed up front, providing an improved IRR. This benefit is greatest where the rent payable is more attractive than the cost of the equity or debt it replaces. Please see Capcore’s article ‘Use cases for a sale and leaseback’ for more detail on using sale and leaseback to fund an acquisition.
Alternatively, sponsors executing a sale and leaseback post-acquisition can crystallise the multiples arbitrage into cash proceeds. Cash distributed to investors in year two of a hold boosts IRR materially more than the same cash received at exit in year five — a sale and leaseback can pull a portion of the return forward, but only to the extent proceeds are actually paid out rather than retained in the business.
Finally, proceeds can be reinvested into the business for a variety of reasons. They can be used to repay debt, reduce leverage and interest cost. Proceeds redeployed into EBITDA-generating capex, M&A or turnaround initiatives can compound into a higher exit multiple. Both of which feed IRR later in the hold period.
The IRR effect is strongest where proceeds are distributed. Proceeds reinvested into the business could support IRR indirectly. It is worth noting that sale and leaseback investors prefer proceeds to remain within the business.
The final word
A sale and leaseback can move both MOIC and IRR but through different mechanics and on different terms. The multiples arbitrage creates equity value when the transaction closes. Direct IRR improvement requires proceeds to be distributed. Further returns can be generated by reinvesting the sale and leaseback proceeds into the business, which sale and leaseback investors prefer. Sponsors need to decide whether proceeds are best deployed to support further growth and returns or distributed to boost metrics at the point of completion.