Capital Markets

Ripe Market for Sale-leasebacks

Two changes in the market have made leasebacks more attractive: lower rents and higher property values.
Don DurfeeOctober 20, 2004

“Leasebacks are definitely on the rise — we’ve seen a huge pickup in business,” says Steve Van Amburgh, CEO of Koll Development Co. (KDC), a Dallas-based commercial developer.

Two changes in the market have made leasebacks more attractive: lower rents and higher property values. According to Reis Inc.’s Andrew Wright, a senior consultant based in New York, the corporate leasing market is still suffering the aftereffects of overbuilding in the late 1990s and 2000, and demand for leases has yet to catch up with supply. Figures from Reis show that average rental prices in the United States have slid from their peak of $29 per square foot in 2000 to just $24 today.

At the same time, low interest rates and uneven returns in the stock market have driven investors — many of them new to the real estate market — to buy properties. “There is a lot of capital looking for real estate, but there isn’t enough property to go around,” says Steve Tinsley, senior vice president of corporate finance at Equis Corp., a corporate real estate services firm based in Chicago. “So we’re seeing some of the highest prices paid for real estate, but some of the lowest lease rates.” These investors are taking on more risk in pursuit of returns — they are willing to accept shorter leases than usual, take on partially vacant properties, and do business with non-investment-grade corporates. “They’ve loosened their investment parameters, and that’s an advantage for corporations,” says Tinsley.

Companies, meanwhile, are using leasebacks for a number of reasons, some old and some new. One is a desire to improve capital efficiency. If a company has investment opportunities that exceed its blended cost of capital, then it may make sense to pull money out of real estate holdings.

Reuters, the London-based information services firm, has taken this attitude. The company recently concluded a few leasebacks for facilities in St. Louis. According to Glenn J. Elliott, senior vice president of real estate services, Reuters considers leasebacks “in cases where we want to be in a property long term and can do a leaseback for less than our aftertax weighted average cost of capital.”

Ed McLaughlin, chairman of USI, a Stamford, Connecticut-based corporate real estate services firm, argues that more growth companies should view leasebacks in this light. “The concern when you move from an owned position to a leased position is your lease rate,” he says. “But with low interest rates driving very low lease rates, asset monetization is attractive.” (For more, see “Leasebacks Are Back.”)