SALE LEASEBACKs (SLB) allow the separation
of ownership from control in the use of real estate reflecting the comparative
advantages of owners and operators. It has a long history in the hotel industry
where the hotel groups manage the hotels which are owned by investors such as REIT.
SLBs are undergoing renewed popularity in the challenged retail and restaurant
industries by firms with substantial real estate assets including Macy’s, Sears
and Darden. This is due, in part, to the recovery in real estate values since
the bottom of the Great Recession in 2009. For example, Sears is using SLBs to
fund continued operating losses to hopefully stabilize the firm. Darden
transferred restaurants like Olive Garden to a REIT, and plans to use the
proceeds to reduce its debt (probably not the wisest use of funds). Activists
are pushing Macy’s to lever up by selling assets to a mall operator and leasing
them back to fund a share repurchase.
There are many reasons, some real - others bogus, for using
SLBs. Bottom line, SLBs are just another form of financing. Their value to the
seller/lessee depends of the sale price, lease terms and ultimately on the use
of the proceeds. Some bogus reasons include:
1)
Improve Balance Sheets by Reducing Assets: need to distinguish accounting from real
effects. In any event, accountants have gotten tougher about removing such
assets from the balance sheet. Even if they do remove them they are disclosed
in footnotes allowing analysts to adding them back.
2)
Improve Debt Ratios: again unlikely as the rent
obligations disclosed in footnotes are easy to add back. Most analysts focus on
EBITDAR (earnings before interest taxes depreciation amortization and rent)
over funded debt plus lease debt.
3)
Monetize Equity: This may, however, trigger
possible capital gains taxes. You can structure the transaction to avoid true
sale treatment to avoid taxes. This usually complicates achieving off balance
sheet treatment for accounting purposes. Finally any book gain realized will be
given back in the new higher lease terms.
4)
Increased Debt Capacity: giving up residual
ownership and flexibility.
5)
Improved Focus: this may have some merit if the
buyer/lessor has a comparative advantage in managing/owning the real estate AND
is willing to share some of that with the seller. There may be a benefit in
expressly charging an explicit rent to better reflect true operating
performance.
As long as the sale price and lease terms are fair, which
you would expect in a large relatively efficient real estate financing market
involving sophisticated parties, there is unlikely to be any value created. You
need to compare SLB against alternative functionally equivalent secured real
estate financing (e.g. mortgage) to determine if market conditions may favor a
SLB over a mortgage.
The second step is to review the use of the proceeds raised
by a SLB. These include:
1)
Capital Structure Change: use to reduce debt in
a potentially over leveraged situation like Darden. This was not well received
by shareholders (possibly reflecting a decrease in Darden’s tax shield and
reduced debt discipline). Alternatively, increase leverage in an under
leveraged situation by repurchasing shares as activists are suggesting for
Macy’s.
2)
Fund Operating Losses as in Sears
3)
Finance an Acquisition/LBO using an Opco-Propco
structure as reflected below:
Be careful of free lunch arguments when
evaluating SLB pitches from investment bankers (e.g. Mesirow ). Focus on
how the transaction impacts firm cash flows and risk to determine the value
impact and not the accounting. Finally, no matter how good the SLB, the key is
the use of the proceeds.
J
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