Sale and leaseback: Do it when you can, not when you need to
Sale and leaseback pricing is determined in part by covenant strength - an investor underwriting a long lease is pricing the certainty of receiving the rent. If investors perceive a heightened risk to that income stream, they will price it accordingly. Characteristics such as declining EBITDA, a covenant breach or a short-term debt maturity can all raise flags during their underwrite. The consequences aren’t limited to a wider yield, it can also narrow the buyer pool and introduce more conditionality.
Using sale and leaseback as a method of last resort
Unless there are strong real estate fundamentals, many net lease investors are credit first in their underwrite. A deterioration in the tenant’s credit therefore moves pricing directly, even where the underlying property remains the same.
Turning to sale and leaseback as a last resort when you need liquidity carries a real risk for both pricing and terms. Investors will discover any potential upcoming distress and price this accordingly with a higher yield. In addition, if the business performance is materially down, the rent might also be reduced (and consequently proceeds) due to affordability concerns. We see this scenario play out frequently with cyclical businesses which pursue this strategy at the bottom of their respective markets.
In these circumstances, investors have leverage to impose terms which are more favourable to their interests. They will often insist on enhanced guarantees or rent deposits if current trading performance is weak. In addition, depending on the level of distress the business faces, the buyer pool could be reduced.
It is still possible to execute sale and leasebacks in these circumstances but expect pricing, terms and liquidity to be significantly worse.
The duration of a sale and leaseback process
A properly run sale and leaseback process takes months and includes vendor due diligence, pre-marketing preparation, a competitive bidding round, bid analysis, exclusivity and signing. Three to six months from a standing start to funds received is a realistic timeline, depending on the complexity of the property or portfolio.
Competitive tension is often a key driver of pricing and this can take time to build. It is aided by full due diligence provided up front and multiple bidding rounds. A business which needs funds quickly often cannot run a complete process. Due to time constraints, sellers might be forced to approach a smaller, targeted investor list or a launch to market without full due diligence. A buyer pool that senses a short, upcoming deadline will price accordingly with the additional bargaining power they perceive to possess.
Executing from a position of strength
Executing from a position of strength will deliver better pricing, terms and liquidity. A sale and leaseback can only be used once and creates a long-term commitment for the business. It is important to use this tool strategically and avoid being pressured in less favourable terms through a weaker negotiating position.
This is not an argument for always transacting early; it is an argument for never being forced to transact late. Evaluate and price your real estate as a financing option - understand what it would attract on a sale and leaseback basis, and what covenant profile supports it. This is a piece of diligence that can be undertaken early, well before it becomes a decision to transact. Once you have undertaken this exercise, sale and leaseback becomes an available tool to fund your next capital requirement or it can be deployed quickly before the business enters a period of distress.
The final word
The businesses that get the best pricing and terms on a sale and leaseback are rarely the ones that undertook the process as a method of last resort. This article is not an argument for always transacting early – a sale and leaseback can only be used once and it should be deployed strategically. However, you should avoid being forced to transact late.
