Sale and leaseback as a tool for value creation
Updated: 6 days ago
Most sponsors adopt value creation routes such as operational improvements, financial engineering and strategic expansion. These methods are hands-on and time intensive. Whilst undertaking these methods, many are overlooking value which already exists on the balance sheet, tied up in a company’s owned real estate.
How can real estate be used to create value?
Real estate is held on balance sheet at book value or fair value, both of which are typically less than sale and leaseback proceeds. Book Value assesses the historical cost minus accumulated depreciation and is often a low figure, especially for assets which have been owned and operated by the company for a long period. Fair Value reflects the value of the property on a vacant possession basis under existing use. Compared to Book Value, Fair Value is more comparable to the level of proceeds achievable via sale and leaseback but a delta often still exists.
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 investor pays a price for the real estate with a secured, long-term income stream attached. The arbitrage between these two approaches is used to create value.
Sale and leaseback investors are underwriting a rental stream and a counterparty's ability to pay it. A mid-market manufacturing business, which might not command a premium equity multiple, can attract a strong yield (the inverse of a multiple) on its real estate. It's a structural feature of the two different markets and not a temporary dislocation.
What is the available arbitrage?
The arbitrage varies as buyout multiples and real estate yields fluctuate but as shown on the table below, an arbitrage between the two has been consistently available. The spread has narrowed from its peak in 2022, but it remains wide and currently presents a strong opportunity.
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.
A worked example of value creation
The table below shows an illustrative example of value creation via sale and leaseback:
The most frequent question we receive when assessing value creation is whether the multiple on the business is reduced at exit as the real estate is no longer owned. Lease structuring is critical for multiple preservation. The lease needs to meet the future operational needs of the business, provide security of tenure where required and have a sustainable rental level without any onerous future uplifts. Where the lease is structured correctly, the multiple isn’t negatively impacted by a sale and leaseback and there is evidence in the market to support this.
Sale and leasebacks are a one-time realisation, not a recurring lever. Once the building is sold, the optionality is gone. Sponsors should undertake this process before an exit to avoid leaving value on the table.
What this means for a sponsor
Sponsors should investigate value creation via sale and leaseback during the acquisition due diligence stage and ideally have a deployment plan before executing. The arbitrage creates value on paper but use of proceeds dictates whether it compounds. We see sponsors creating further value by using sale and leaseback proceeds to accelerate the business plan, support EBITDA generating Capex, fund M&A, refinance or deleverage.
The final word
The arbitrage exists because two markets price the same building differently. The sponsors which understand the opportunity can access another value creation lever which is sat on the balance sheet, overlooked by previous owners.