Sense and stability

When finance is desperately hard to come by, acquisitions are thin on the ground and revenue from tenants is increasingly unreliable, it would seem that both investors and owners are in a bit of a fix. But maybe not, if they go for a solution that is still novel in the region

 Nathan North

As the dark days of the credit crunch drag on seemingly without end, we could all be forgiven for clutching at straws of hope wherever we think we find them. According to consultants CB Richard Ellis, in the first half of the year the volume of investment in CEE real estate was down by more than 90 pct on H1 2008, and by 86 pct on the previous half-year – figures which go some way to reveal the extent of the damage done by the shockwaves from last year’s financial meltdown. But at the end of July, news came in of one deal that might just provide us with a ray of hope: Tesco had sold and leased back its entire Hungarian logistics portfolio to US investment company W. P. Carey for EUR 63 mln – in these times, a massive deal. There are also (as yet unsubstantiated) rumours on the market that a simultaneous sale-and-leaseback deal was agreed with Deka Immobilien for the latter to buy Tesco’s Polish and Czech logistics properties. So how did such transactions materialize, when it would seem that no-one wants or is able to buy real estate on such a scale? And why did the deals take the form that they did – sale-and-leaseback – when this particular type of transaction is still rather novel in this region? Indeed, the first such deal in Poland only took place as recently as in autumn 2005.

To explain the attraction of such transactions, I turned to Wojciech Pisz and Aleksander Loster of Cushman & Wakefield’s capital markets group, the consultancy which represented Tesco during the negotiations. According to Aleksander Loster: “These days, this is a way for companies to introduce some liquidity.” Wojciech Pisz adds to this that what may make these transactions attractive is that this is one of the few methods of financing still open: “When banks are more-or-less closed for loans, it’s a way to release fixed assets and equity.”

Never-considered alternative at hand

On the other side of the Tesco deal is Jeff Lefleur, executive director of W. P. Carey International, which describes itself as “an investment management company that provides long-term sale-and-leaseback financing for companies worldwide.” Mr Lefleur agrees that it is the current situation on the financial markets that is leading companies to perhaps take a closer look at a form of deal that they may be unfamiliar with: “Sellers are faced with a lack of traditional financing, so they are considering alternatives.” As he goes on to explain: “Sale-and-leaseback is an alternative form of financing, so we compete with traditional capital markets – bank lenders and private equity funds, for instance – but these traditional sources of financing are very difficult at the moment. So this type of transaction is becoming a viable option for companies that have never considered it before.”

Before the credit crunch, sale-and-leasebacks may have been viewed less favourably. In Jeff Lefleur’s experience: “When investors and lenders are competing for deals, this is often seen as a rather expensive alternative – and we had such a situation up until 2007, when sometimes companies approached us and saw that bank loans and selling shares were cheaper ways to raise finance.”

    From the buyers’ point of view, when markets collapse, it is always a good time to make acquisitions – or rather, it is for those who can still buy and have the nerve to do it. “We can make deals with companies with far better assets and credit, and at yields that are better than in 2007,” reveals Mr  efleur, adding that “on a risk-adjusted basis, this is a good time to be a sale-and-leaseback investor.” Aleksander Loster believes that it is also the stability of sale-and-leasebacks that has brought them into vogue at a time when investors might be wary of making the wrong move: “Investors right now are very risk-averse, and looking for long-term, secure income. ‘Sustainability’ is the key word at the moment. The stability of the transaction means there is a good demand for sale-and-leasebacks,” His colleague, Wojciech Pisz, claims that currently “there are many investors looking for this type of transaction, or properties that can be treated like this – with long leases, stable tenants – across all sectors. There are not too many issues for investors to have to deal with.”

Frozen fish and blue chips

So it would seem that both sellers and buyers can be happy with this solution to the freeze in market activity. From the sellers’ point of view, a source of financing is still available to them through the sale of real estate, while buyers can enjoy the benefits of a transaction with a good yield and the security of having stable tenants and a long-term lease. However, investors in this niche, in their desire for deals with long-term stability, tend only to look at companies with a solid financial grounding. As Wojciech Pisz explains: “There are some companies that are in trouble and looking to improve their financial stability. But this type of transaction is more difficult for them as it is based on the financial covenant of the tenant; so if the company is not ‘blue-chip’, then the terms of the contract would probably not be satisfactory.” Jeff Lefleur adds to this that it is not only the quality of the tenant, but that of the property which is also crucial: “If we can’t get a deal with a long-term lease secured by a creditworthy tenant and involving a strategic property, we are simply not interested.”

Fear of the unknown

But even if such companies sitting on prime real estate can be found in the CEE region, there are a number of snags involved in sale-and-leasebacks in a part of the world where the format is still rather unfamiliar, to say the least. Mr Lefleur believes that the first problem for the region is that “there is not a tremendous amount of legal precedent for such long term deals, so they are dependent on the power of landlords and the strength of the legal system.” He goes on to add to this that: “This type of deal has only been around for 5-10 years in the region, whereas in France and the UK the method is about 100 years old, with the legal precedents to support it. Since it is a new form of financing in the CEE region, there is little way of knowing what might happen in the future.”

A second major risk for sale-and-leaseback investors that Mr Lefleur points to concerns the complications that arise from having rents quoted in euros while the economy is run in local currency – as is generally the case in the CEE region. In his view: “The ability to make large euro-based transactions can be stretched. Any country that adopts the euro is more attractive than those that do not.” Nevertheless, W. P. Carey remains undeterred from investing in this part of Europe: “These are risks we have to consider. We need proper counsel, and to be aware that this is a new environment,” states Mr Lefleur. “I believe the level of owner-occupied real estate in the CEE region is quite high, and is often owned by those who have never considered sale-and-leaseback.”

    Despite all the potential pitfalls, Aleksander Loster expects this to be the dominant form of transaction in this region in 2009 and for H1 2010. However, if an upturn finally arrives, then more flexible methods are likely to return to the fore: “It might happen that there will be less of this type of transaction when the recovery comes, when there is more choice on the market. A sale-and-leaseback is a long term deal after all.” Most players on the market are clearly hoping that this time arrives sooner rather than later, but for the moment the prospect of more sale-and-leaseback deals provides us with some hope that the market is finally flickering back to life once again.