Staying power

Staying power

Total Property - Issue 6 2018

Moving from owner to tenant should not be seen as a backwards business step. Divesting an expensive asset can be a catalyst for business growth, without disrupting current operations.

Other reasons a business may go down the sale and lease back path include:

• seeking an improvement in the bottom line and the figures around return-on-assets, return-on-equity, debt-to-equity and asset-to-liability ratios

• allowing a focus on core business operations rather than managing property

• increasing a company's value by redirecting real estate proceeds towards productivity, financing dividends, stock purchases or debt payments or to facilitate a merger/acquisition

• the ability to leverage off the tax-deduction benefit of rent expenses versus the tax advantages of depreciation and interest-payment deduction

• off-setting net operating losses.

A business that intends to occupy the property for the long term will be targeting investment grade purchasers who generally seek leases of nine to 12 years with renewals, strong tenant covenants, good rental returns and high quality buildings.

If the business is looking to expand, retrench, or change tack and doesn’t wish to get locked into the restrictions of a long-term lease, and/or the property has development potential, then the marketing campaign could target developers seeking a short-term rental income opportunity while they get their financial and planning ducks in a row for future development.

From the seller’s perspective, rental value, lease terms, renewal option periods and the recovery of outgoings will all impact a property’s market value. The final commercial terms are equally important to investors, given that those terms will dictate their likelihood of favourable commercial lending rates on the basis that the asset has a level of gearing attached to it.

Independent professional advice is vital here, as key lease term decisions need to be balanced against the upfront value versus the ongoing impact they may have on the business.

Chris Leatham and Richard Chung, partners in PwC’s Wellington office who specialise in advisory services, say the question of “why and when” to sell operational real estate assets is subjective.

“The most common reason for exiting operational real estate assets is to release capital, or to restructure balance sheets”, says Leatham.

“These are rational decision drivers, but what also needs to be considered are the potential consequences, and how outcomes can be maximised from such a strategy.

“At one extreme, a specialised asset which is fundamental to business success and for which control is required (referred to as a core asset) should, all else being equal, be owned,” he explains.

“In contrast, assets that are generic, in ready supply and which are not essential to business (non-core assets) could be leased.”

Ultimate control rests with ownership. While some control can be retained via the negotiated lease, a business may not be able to expand its real estate requirements to match the business’s requirement with the same flexibility so the core business strategy needs to be the driver here.

“Then there’s capital efficiency with flexibility and risk being the key considerations,” says Chung.

“Your business may or may not be the best entity to own a particular asset given the maintenance, capital expenditure and funding requirements.

“Linked to this is the impact on financial ratios and bank covenants – real estate offers strong collateral and leverage potential, but it also ties up considerable capital that might be better applied to investment in other forms of business growth initiative.”

Read more market insights from Total Property

Subscribe to receive the latest commercial news and insights from Bayleys Total Property