Starmark Holdings, a Denver-based health club operator, needed cash. But the company was determined not to take on more bank debt to take advantage of promising acquisition opportunities. So three months ago the privately held company hired real estate investment firm W.P. Carey & Co. to put together a $178 million sale-leaseback transaction. Starmark sold off 15 of its 33 Wellbridge health clubs and leased them back under a 20-year rental agreement.
The deal was old hat to W.P. Carey, which has seen its sale-leaseback volume balloon from $395 million in 2001 to $1 billion last year. This year it expects to do $2 billion worth of these transactions. “More companies today want to raise capital through a mechanism like a sale-leaseback,” says Gordon DuGan, Carey’s co-CEO. “It is an alternative form of capital.”
Starmark, for its part, plans to make good use of its newfound financial flexibility. “Rather than have capital tied up in real estate, we prefer to have capital to improve our club operations,” says Gregory Camia, a senior vice president at Starmark.
In a sale-leaseback a company sells a property and then rents it back from the new owner. Institutional investors can participate in these deals in two ways: by taking an equity stake through direct investment, a real estate investment trust or a commingled fund, or by supplying debt in leveraged transactions, generally through private placements.
All told, sale-leaseback volume could hit $12 billion this year, up from about $6 billion in 2001, according to CRIC Capital, a Boston-based investment firm.
Part of the expected increase will come from the big backlog of deals left over from 2002, when volume plummeted to just $2 billion. In the wake of corporate accounting scandals, companies held off on completing highly leveraged sale-leaseback transactions for fear that they might be required for the first time to record them on the balance sheet as a liability rather than as an operating expense. But a January ruling by the Financial Accounting Standards Board makes it clear that companies can avoid consolidating them on the balance sheet. “An overhang of uncertainty has been lifted from the marketplace,” notes Ethan Nessen, a principal at CRIC Capital.
These days more and more companies are turning to their real estate portfolios to raise cash to pay down debt, fund new ventures or reinvest in existing business lines. “Companies have a need for capital,” notes Debra Moritz, chief operating officer of the strategic consulting group at Jones Lang LaSalle, a real estate investment firm in Chicago.
For institutional investors sale-leaseback transactions offer a steady income stream with the added security of a hard asset behind the investment. “A sale-leaseback offers a stable return and can help investors diversify their portfolio,” says Steven Bardsley, a managing director in the capital advisers group at Insignia/ESG, a New York based real estate services provider.
In W.P. Carey’s sale-leaseback deals, rental agreements typically last for 15 years. In December, for example, the firm closed a $125 million sale-leaseback with TruServ Corp., a Chicago-based hardware wholesaler that operates under the TruValue and other retail names. The deal included the sale-leaseback of seven distribution centers. TruServ has used the proceeds to restructure senior debt.
Among the institutional investors in sale-leasebacks, Commercial Net Lease Realty, an Orlando, Floridabased REIT, keeps about one third of its $1 billion in assets in sale-leasebacks. “We have a creditworthy property occupied and cared for,” says CNLR president Gary Ralston. “And we get a reliable income stream.”
Demand is strongest for sale-leaseback deals that involve tenants with credit ratings of single-A or better and a quality location that should be easy to rerent. Properties that are well managed but below investment grade are piquing interest, too. Says W.P. Carey’s DuGan, “Institutions can lock in steady returns because they have a known tenant for a period of time, backed by a hard asset.”
