As economy worsens, more companies seek to divest real estate
A few years ago, AT&T became an active player in the real estate market - not as a buyer but as a seller. The telecommunications giant sold its office towers in a number of cities, including Dallas, Cleveland and Chicago, but has continued to occupy and control these buildings.
Taking advantage of a healthy market for so-called sale-leaseback transactions allowed the company to free as much as US$1.5 billion, according to one broker’s estimate.
Among the properties sold were a 42-storey office tower in St Louis and the 47-storey building in Atlanta which AT&T had acquired in its merger with BellSouth.
The sale-leasebacks were ‘part of a strategy to get out of the real estate business, which is not a core business or interest of our company’, said AT&T spokesman Fletcher Cook.
Large corporations are usually loath to say much about the process of transforming themselves from owners to tenants, and often the transactions are not even made public. Mr Cook would not estimate how much real estate AT&T had sold in recent years.
But brokers say that AT&T’s timing was good. Like all forms of real estate investment, the sale-leaseback market flourished in mid-decade but has all but stalled in recent months as financing has dried up.
Sale-leaseback deals of industrial, office and retail properties last year totalled US$7.3 billion, compared with US$15 billion in 2007, according to Real Capital Analytics, a New York research firm that tracks sales of US$2.5 million or more.
In the last quarter of the year, only US$514 million in sale-leasebacks were recorded.
The pool of buyers has diminished as some of the more active participants, including GE Real Estate, IStar Financial, First Industrial Realty Trust and Lexington Corporate Properties Trust, have been sidelined by financial difficulties.
Investors in sale-leasebacks have been especially skittish since HSBC, the British bank, sold its headquarters in London’s Canary Wharf to Spanish developer Metrovacesa in April 2007 for £1.09 billion (S$2.34 billion) and the buyer was unable to refinance the loan it took out to close the deal, said Robert White Jr, the president of Real Capital Analytics. The bank repurchased the building for £838 million.
Yet as the economy has worsened, an increasing number of corporations - especially those whose bond ratings are less than investment grade - are clamouring to divest themselves of their real estate through sale-leasebacks.
‘The companies interested in doing it are the ones that people want to stay away from,’ said Randy Blankstein, president of Boulder Net Lease Funds, a company in Northbrook, Illinois, that invests in buildings with single tenants. ‘A lot are being offered, but few are being executed.’
Last autumn, for example, General Motors explored the possibility of selling its Renaissance Center in downtown Detroit, but the distressed car company found no takers.
For troubled companies, sale-leasebacks provide an alternative means of financing that can be used to pay down debt. The seller can free up the entire value of the property rather than just 50 or 60 per cent, the maximum loan-to-value that would be allowed today.
In addition to rent, the seller continues to pay taxes, and utility and maintenance costs.
Many investors insist that the seller’s credit be rated investment grade. ‘There are deals you could have done in 2007 that you just can’t do today,’ said Sidney Domb, president of United Trust Fund, a Miami company that (in a joint venture with GE Real Estate) owns the corporate headquarters for Belk department stores in Charlotte, North Carolina.
Some companies, however, are willing to take on riskier deals, but they expect to be compensated accordingly.
‘Investors are much more cognizant of the differences in credit than they were a year or a year and a half ago,’ said Brian Scott, who manages the sale-leaseback group at CB Richard Ellis, a commercial real estate company. ‘There has been a repricing of risk.’
Last week, The New York Times Co. confirmed that it was in advanced negotiations with one leader in the sale-leaseback industry, WP Carey & Co of New York, to sell 19 floors of its new headquarters building in Midtown Manhattan for an undisclosed price. (The Times Co had said it was seeking a price of up to US$225 million.)
Under the terms of the deal, the Times Co, which owns 58 per cent of the 52-storey building, would continue to occupy and manage its space for the 10-year life of the lease.
On Friday, Moody’s Investors Service downgraded the company’s unsecured senior bonds, taking the same step that Standard & Poor’s took in October.
Neither WP Carey nor the Times Co would comment on their negotiations.
Michael Rotchford, an executive vice-president at Cushman & Wakefield who is advising the Times Co on the sale-leaseback, also declined to talk about the pending deal.
Popular in the 1970s and 1980s, sale-leasebacks lost their appeal for a while when certain tax advantages were eliminated. But as the demand for real estate intensified in the middle of this decade, the market for sale-leasebacks caught fire, said David Cobb, chief executive of BentleyForbes, a Los Angeles real estate investment company that used to focus only on such transactions.
But it broadened its business to include buildings with several tenants in 2005 because of the growing risk that it saw in sale-leasebacks.
‘The terms of the deals had swung heavily toward the tenants versus the landlord,’ Mr Cobb said.
Sellers were able to insist on greater flexibility, including shorter lease terms and the opportunity to give up some of their space if their business contracted, he said.
These days, however, buyers enjoy the upper hand. Unlike the proposed 10-year lease for the headquarters of the Times Co, the normal lease term now is 20 years, said Gerald Levin, who leads the sale-leaseback practice at Mesirow Financial, a company based in Chicago.
The New York Times deal would be unusual in other respects.
Sale-leasebacks are rare in New York because most buildings have multiple tenants. In 2007, however, Deutsche Bank sold its 47-storey headquarters building at 60 Wall Street to the Paramount Group for nearly US$1.2 billion in a 15-year leaseback arrangement. (The bank also financed the deal.)
Gordon Whiting, a managing director at Angelo, Gordon & Co of New York, which recently acquired the headquarters and distribution centre for Conney Safety Products in Madison, Wisconsin, said owners of Manhattan real estate do not want to miss out on the likelihood that their building will increase in value over time.
‘They haven’t wanted to sell them because they think they’re giving up that appreciation,’ Mr Whiting said.
Another unusual feature of the proposed agreement with WP Carey would give the Times Co the right to buy back the space for a predetermined price. That would mean the lease would be listed on the company’s balance sheet as a liability, rather than as an off-balance sheet transaction that does not add to its debt, leaseback specialists said.
Many companies seek sale-leasebacks to improve their balance sheet.
For WP Carey, a 35-year-old public company that also operates four non-traded real estate investment funds - marketed to the public by financial advisers - the deal with the Times Co would offer not only a stable rental stream but also a chance to capture a negotiated increase in the property’s value. The company says its annual returns since 1979 have averaged 11.56 per cent.
In its most recent annual report, WP Carey described its investment philosophy: ‘We seek to invest in properties that are strategically important to the operations of the tenant company, so that even if that company has some financial difficulty, it needs to keep the lights on in our buildings to run its business.’
