In the current low interest rate environment, corporate Australia is revisiting their property occupancy strategies to unlock value. For companies that own and occupy their property, a sale and leaseback transaction can be an astute business strategy. At the same time, the sale can provide attractive, long-term assets for funds and their investors.
Company ability to monetise an asset
Given the strong demand from both listed and unlisted property funds for long-term leased properties, together with the historically low cap rates (yields) at which these properties currently trade, it is an ideal time for corporates to monetise their property assets through a sale and lease back transaction.
A sale and leaseback arrangement effectively separates the ‘asset value’ from the ‘asset’s utility value’. A company can crystallise value and redeploy the capital tied up in a low-yielding property back into their business at higher rates of return in a more productive use. This might include acquiring another other business, paying down debt, or undertaking a return of capital to shareholders via a special dividend or share buy-back.
Sale and leaseback transactions have become particularly attractive to private equity firms acquiring ‘property rich’ companies. By carving out the property from the business concurrent with, or post, acquisition, the private equity owner has the potential to unlock a materially higher value for the asset than they paid for it. Often, there is a disconnect between a lower cash flow multiple paid to acquire a business which is property rich and the higher cash flow multiple placed on an asset-light enterprise.
How a company retains control and flexibility
With debt costs at record lows, an easy option for corporates is to utilise debt capital and borrow to assist in funding their business. However, the debt is typically only available for a short period of time (say three to five years) creating rollover risk. It may also come with arduous covenants, and only unlock between 30% and 65% (loan to value ratio) of the value of the property.
Given the low cost of debt, the lease payments under a sale and lease transaction may be more expensive than the interest payments on the debt, but a sale and leaseback can provide greater certainty to the company due to a long-term lease. The company can also secure 100% of the value of its property assets in cash.
For many companies considering a sale and leaseback, the ongoing control and use of an operationally critical property is paramount to the long-term objectives of the business. An appropriately structured sale and leaseback can allow the tenant to retain possession and continued use of the property for the lease term.
Typical sale and leaseback leases are triple net which means the tenant is responsible for outgoings, repairs and maintenance and most capital items. The leases are for between 10 and 20 years, although in some cases may be longer. The company may also negotiate lease extension options giving even longer-term certainty. In some cases, they may include terms for early lease surrender if more flexibility is required, and the new owner is comfortable to take on the risk of reletting or converting the property to an alternate use down the track.
Examples of long-term sales and leasebacks
Charter Hall has been involved in more than $6.5 billion of sale and lease back transactions in the past few years with high quality, creditworthy covenants such as the Federal Government, BP, Telstra, Coca-Cola Amatil, Ingham’s, Bombardier Transport, Virgin Australia, Arnott’s, Bunnings and Woolworths. These transactions span a range of property sectors including office, industrial, social infrastructure, pubs, convenience retail, fuel outlets and large format retail.
In one of Australia’s largest sale and leaseback transactions, in August 2019 Telstra sold down a 49% interest in 37 telco exchanges to a Charter Hall led consortium for $700 million. The deal was struck on a capitalisation rate of 4.4%.
Telstra’s CEO, Andy Penn, said the deal was part of Telstra’s strategy of monetising up to $2 billion of assets to strengthen its balance sheet. Under the terms of the transaction, Telstra retains a 51% controlling interest in the entity that holds the assets and retains operational control of all the exchanges. In return, Telstra signed a long-term triple-net lease with a weighted average lease expiry of 21 years, with multiple options for lease extension to accommodate ongoing business requirements.
Opportunities for investors
More recently, private equity giant KKR, as part of their deal to buy iconic biscuit manufacturer Arnott’s from Campbell Soup Company, immediately on-sold Arnott’s Australian production facilities. Charter Hall’s acquisition, through its unlisted Charter Hall Prime Industrial Fund (CPIF) and the ASX-listed Charter Hall Long WALE REIT (ASX:CLW), of Arnott’s 59,000sqm facility in Huntingwood in Western Sydney for $397.8 million, on a passing yield of 4.5% is one of the largest individual industrial asset sales recorded in Australia.
Arnott’s signed a 32-year triple net lease with multiple 10-year options giving certainty of tenure over their premier Australian production facility, as well as unlocking significant capital to the new business owners.
The 32-year lease and uncapped CPI plus 0.5% annual rent reviews provide an attractive long-term investment with inflation protection to the CPIF and CLW investors.
Companies should consider capitalising on the growing demand from property investors for long-term predictable income returns as part of their overall capital management plan. A well-structured sale and leaseback programme provides access to an alternative source of long-term capital which can enhance the overall capital efficiency and value of their business, and place the asset in the hands of investors seeking long-term income security.
Adrian Harrington is Head of Capital and Product Development at Charter Hall, a sponsor of Firstlinks. This article is for general information and does not consider the circumstances of any investor.
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