Back in the early-1990s, Baptist Hospitals added two medical office buildings to its Nashville campus. Theproject was big, about 390,000 sq. ft. of space, and expensive, million in construction costs, but successful in that it brought physicians closer to the hospital and improved patient care.
There are anumber
of benefits in controlling a medical office building on the campus of a hospital, "but it was tying up a lot of capital," says Calvin MacKay, executive vice president and CFO for Baptist Hospitals.Baptist Hospitals wanted to continue to control the properties. Yet at thesame time, it wanted to get a better return on its investment. "I wanted to get the money to work for me and having it tied up in the medical office building wasn't doing that. There was a better way," MacKay says.
The better way, as it turnedout, was a sale/leaseback. Baptist Hospitals sold the office buildings at net book value to Staubach Financial Services in Dallas then leased the property back for 22 years with four, 10-year renewal options. In addition, Baptist Hospitals still owns the ground under the buildings.
"I was able to move those office buildings off my balance sheet and turn them into cash," says MacKay. "I now have cash givingme a return that is flowing through my income statement. I increased my earnings on my income statement, increased my fixed assets and increased my return on assets on the balance sheet. Depreciation was also gone, but the balance sheet did pickup the lease expense."
In many ways, the big advantage of a sale/leaseback is the flexibility it provides, says Charlie Corson, a senior vice president with Staubach Financial Services. "Depending on what the lease can offer, the tenant can dose the store, open the store, sub half the store, redesign the store, renovate the exterior or interior and never have to confer with the landlord."
Market still busy despitenew rules
The market for sale/leasebacks in some regards is still very active but, in other ways, a bit more restrictive than theboom period that began in the 1980s. In those years, there were a lot of deals being done with corporate headquarters and even nuclear power plants, says Jeffrey Giroux, a partner in the New York office of Arthur Andersen. "It used to be that you could have a purchase option or guarantee the value of the real estate orcould extend the renewal option. But in the late-1980s, FASB (Financial Accounting Standards Board) came out with new accounting rules for real estate sale/leasebacks that had some onerous provisions."
The amountof sale/leasebacks being done is about on par with other years, says Jim Clifford, an associate director at Cushman & Wakefield, San Francisco. But this year, he has seen more of a focus on companies trying to get rid of surplus real estate, which diminishes the needto do sales/leasebacks. However, the pressure on companies, especially public companies, to keep real estate off the balance sheet is still strong. A big part of an analyst's evaluation is how undervalued a stock is and how the company is allocating its resources, Clifford says.
Back when Core Resources of Auburn Hills, Mich., wasVolkswagen of America Inc.'s in-house real estate department, it led its company through two sale/leaseback transactions: one deal back in the mid-1980s where it sold a subsidiary's distribution and office facility in Connecticut for million and a million deal for 629,000 sq. ft. of warehouse and distribution space in Los Angeles, Chicago and Jacksonville back in 1993.
"In regard to the latter deal, Volkswagen wanted to free up funds for other purposes," says Michael Carroll, a principal at Core Resources. "They had anumber of properties on their balance sheets that were long-term strategic holds, and they wanted to keep and use them but wanted the cash out of the properties."
How to make the deal
Back in the early-1990s, RexTV & Appliance, the biggest retailer of televisions and appliances in small town America with 220 stores, worked a sale/leaseback of 50 stores with a SanFrancisco company called TriNet, which today is the largest real estate investment trust that owns and acquires predominantly office and industrial properties net leased to major corporations.
What Rex TV & Appliance wanted to accomplish, says Stuart Rose, chairman of the Dayton, Ohio-based company, was to use the proceedsof the sale/leaseback deal to buy back stock. in that regard, the transaction achieved its desired result. "The overall effect to the shareholder was that we shrunk our share base by over 50% and then, when our earnings went up again, all the shareholders got twice the earnings they would if itwasn't for this transaction."
Dealing with retail sale/leasebacks
The world of sale/leasebacks can basically be divided into two camps, corporate and retail, and companies that arrange sale/leasebacks often specialize in one or the other. TriNet, forexample, aims for the office and industrial properties, while Commercial Net Lease Realty Inc., an Orlando-based REIT, focuses on free-standing, single-tenant, street corner retail locations.
"All we do is retail, and there is a specific reason why we believe that retail properties are unlike other types of real estate. They are locationally specific," says Gary Ralston, president of Commercial Net Lease Realty Inc. "The value of that particular retail site is unique to that particular location."
Making corporate deals
"Although retailers havebeen
the predominant user of the sale/leaseback structure, all investment-grade corporations should consider sale/leasebacks when they are about to investin real estate for corporate use," says Lynn Gray, vice president/originations at Capital Lease Funding L.P., which is able to provide loan proceeds for the borrower equal to 100% of the fair market. "Most corporations are not in the real estate business and should not tie up their capital in real estate which does not provide any current return on investment."TriNet, which was formed 11 years ago and went public in June 1993, takes a different track thanCommercial Net Lease. It boasts a strategy of acquiring and owning predominantly suburban office and big bulk-distribution assets. Generally, the assets are leased long-term to major corporate tenants on a triple net lease basis. It has over the years acquired 110 properties valued at justunder billion in 27 states.
"The common themeamong
corporations today is that they don't need to own real estate. Companies can lease and that gives them more operating flexibility." says Mark whiting, TriNet's president. "The popularity of sale/leaseback transactions will increase considerably as corporate finance executives realize that the property on their books can be a useful source of capital. Selling and leasing back operating real estate allows corporations to reinvest capital to earn a higher return on assets and equity while continuing long-term occupancy of the property."Working with middle market firms
Bedminister Capital LLCwas
formed two years ago to do sale/leasebacks for middle market companies. The Bedminister, N.J.-based companytries to do million to million in deals annually although, as vice president Gary Sopko says, Bedminister will probably fall short of that goal this year mostly because "these transactions often take a considerably longer period of timeto close than anticipated."Bedminister likes the middle market companies because "often times these companies get themselves into positions where they have a wonderful plan as to how they can continue to grow and expand the company, but they have limited capital resources to do it, and thebanks have no interest these days in providing expansion capital," says Sopko.
What is a synthetic lease?
Over the past few years, Staubach Financial Services has gained a reputation in an area called the synthetic lease, which is similar to a sale/leaseback but is an off-balance-sheet deal of shorter duration.
"Synthetic leases have been most attractive to those companies for whomthe cost of long-term borrowing is very high or for whom long-term debt is not available," says Zuckerman Gray of Capital Lease Funding. "Fees are low and, although the term of financing is shorter than the traditional sale/leasebacks, these credits can borrow at very attractive rates, take advantage of the tax and accounting benefits (for as long as they last) and refinance withina few years when their credit rating may have reached investment-grade status, making it much more attractive for them to complete a 15- to 20-year sale/leaseback."
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