To lease or not?

© convisum – 123RF.com

Research suggests selling existing property assets and leasing back the same building or new premises.

According to Tony Bales at Epping Property, "the opportunity lost from not actively using the cash tied up in property, outweigh most benefits of direct property ownership by corporate organisations.

"Although the basic debate between direct ownership and leasing has always been around, with some indication of a cultural bias toward ownership, the past couple of years have brought the issue more sharply into focus."

Higher expectations by shareholders and equity partners meant many companies were coming under greater scrutiny. "Companies don't have the luxury of being able to produce average returns in today's market. Shareholders expect much more than that these days and the attitudes of directors have also changed. On an ongoing basis, the re-investment of that money into the core business of the company is usually going to have enormous ongoing benefits.

"In most cases the decision boiled down to a basic equation," he said. "If you are a retailer and you usually have about a 25% return on your funds from the retail business, why would you have money tied up in property? Unless it is actively managed, the returns will not be substantial enough."

One of the main arguments given by companies for their decision to own a property rather than lease is because it offers greater control over the site and therefore greater flexibility to use the property in the manner it wanted.

"However, from a physical or operational view, it makes little difference if the company was the legal owner or the tenant of the property," says Bales. "Furthermore, experience has shown time and again that where the lessee is a substantial company, the value of its rental covenant is itself sufficient to place the company in a position of strength when it comes to dealing with the owner."

An example is when executives at Reader's Digest met to discuss how to free up some cash to funnel back into its main businesses - the answer lay in the publisher's huge Canary Wharf headquarters in London. The chief financial officer stated that they realised they should not be in the real estate business and so Reader's Digest sold the complex for nearly $100 million and is now leasing back space in the building, a move that Wall Street has applauded and that has left investors very pleased through the investment of that cash in new content and distribution channels instead of having it sitting in the ground. The sale also represents about $1 a share for investors.

Sale and leasebacks

According to Bales, this thinking is also evident in South Africa where there have been a number of sale and leaseback transactions.

"This is an increasing trend with scores of firms raising large sums of cash without visiting the stock or debt markets. They are simply selling their office and manufacturing properties and then leasing back the space. Sale and leasebacks, as the transactions are called, aren't a new concept, but they have picked up speed over the past months, as companies perceive the real estate cycle to be near its peak."

"The trend has gained steam of late for several reasons. For one, publicly traded companies in all industries are under pressure by investors to shed non-core assets and focus on their main businesses. Also, massive layoffs and big mergers in the past few years have left many companies with lots of excess space. We are seeing organisations from the largest listed companies to private emerging companies using this as a financial vehicle. From the company's side, it's the pressure to continue to increase earnings," says Bales.

"Of course, healthy property prices are also driving companies to consider getting their property off their books. No one is saying that prices have peaked, but many of the companies certainly feel they are getting a good price for their properties these days.

Nationally, office-property prices jumped an average of almost 10% in 2013 from the year before. Real estate companies, meanwhile, are using these higher property prices to push even more sale and leasebacks."

"One of our philosophies," says Bales, "is that if you're not in the real-estate business, in most cases you shouldn't own property. Sale and leasebacks typically make a company's balance sheet more attractive by increasing the return-on-asset figure that number analysts consider when making their share recommendations. Analysts typically don't give much weight to owned real-estate assets in evaluating companies, because such assets are seen as liquid.

On the other side of the equation, buyers benefit because rental rates are still rising across the country, so they can lock in healthy leases that will provide solid returns for several years.

Bales concludes that what distinguishes a smart sale-lease-back transaction from a dumb one all depends on what a company does with the cash raised from the sale of the real estate. "Companies that redirect the money into a prudent acquisition or some other fast-growing investment, or who use it to lower debt, will benefit from sale-leaseback transactions.

For more info, contact Epping Property on 021 531 0026, email az.oc.ytreporpgnippe@ofni or visit www.eppingproperty.co.za.