Sale & Lease Back – Why and how? Selling a property and simultaneously leasing it back – a conversation with Lars Frölich
Sale and lease back as an asset based alternative financing and source for liquidity is not a today’s innovation. However, there is a trend of an increasing number of selling a property and simultaneously leasing it back. Lars Frölich, Senior Vice President, JLL Switzerland, answers questions regarding financial and operational benefits of a sale and lease back, how the rent should be defined, and the rights and obligations that are resulting from entering such a partnership.
What are the financial benefits of selling and leasing back a building?
Lars Frölich: These days with high real estate valuations, hidden reserves can be realised, equity is created, and liquidity is released. The unlocked capital can be invested into the core operations in many kinds, into process optimization or for business growth. Further, optimizing the capital structure by means of debt amortization or dividend distributions are enabled. The important questions one should address are about capital allocation. How much capital shall be bound in the company and, specifically, for which business activity.
In a situation of a planned medium-term sale of the entire corporation, either as part of the succession planning or an exit of a private equity firm, the sum-of-the-parts valuation can increase. This is called a multiple arbitrage as, often, real estate is valued with a higher multiple than the business is. Selling the property and the operations separately, also allows to focus on finding the new best owner for each part. The reduced volume for the company’s succession can be decisive, as it may facilitate or even enable the acquisition by the desired vendee.
«A sale and lease back is filled with conflicts. Profit today or future profit needs to be balanced with operational needs.»
Are there further motivations?
Lars Frölich: Yes, there are operational benefits from a sale and lease back transaction, too. Flexibility is created to vacate a site once the fixed lease term is expired. When the strategy of vacating the building is already firm at the moment of entering the sale and lease back, it can be a win-win-situation for seller-tenant and real estate investor. During the lease back period, the investor has a stable cash flow. In parallel a new tenant can be searched, or an alternative usage of the property can be developed and prepared. And the seller-tenant receives a better sales price compared to the vacant possession sale later.
What is better: low or high rent?
Lars Frölich: This depends on various aspects. Basically, selling and renting back a property is filled with conflicts which need balancing and setting of priorities. Just one example: high sales price now or lower rent with higher operating profit in the future – which is considered a traditional management generation conflict. We recommend to also consider the interests and common standards of the real estate capital market aside of internal structuring and optimization. Thereby, over-proportional risk premiums or even poison pills that reduce transaction liquidity can be prevented.
Is it possible to continue controlling the building in one’s new role as tenant?
Lars Frölich: It’s not only possible, it’s highly recommended. Our client advise follows the approach “operations first”. To be more precise, a building needs to be adjustable to the ideal workflow of its user. As best as it can, a building needs to support the best operational process. This means the most efficient logistics within the building, the possibility to adjust the building’s construction in case of changing demands as well as regarding representation and appearance. To minimize potential conflicts and necessary coordination efforts among the seller-tenant and the new property owner, the lease agreement and the interface list with responsibilities should provide a maximum level of freedom to the tenant.
Do these rights come along with obligations?
Lars Frölich: A clear yes. But a business interruption because of a defect of a goods lift is much worse and much more expensive than conducting regular service and maintenance work at a convenient time. A wanted high involvement and high level of responsibility of the seller-tenant leads to passivity of the new property owner. Such a passive structure often is a hunted investment opportunity, which typically, supports the maximisation of the sales price. In addition, the seller-tenant knows the building’s technical infrastructure and construction best. By remaining responsible, information asymmetry and potential risk premiums are minimized or avoided.
Daniel Stocker, Head of Research, in a conversation with Lars Frölich, Senior Vice President, JLL Switzerland.