Sale leasebacks have been a financing tool for some time. However, they have been steadily gaining popularity for manufacturing companies to raise capital.
Essentially, a sale leaseback transaction occurs when a manufacturing company sells its property and then leases the same property back from the new owner. This simultaneous sale and leaseback of a facility enables a manufacturing company to unlock capital tied up in real estate.
Manufacturers have leveraged the proceeds from sale leasebacks in a variety of ways, including funding growth initiatives, purchasing new equipment, and installing next-generation production lines. Some companies pay down debt — which lowers interest costs and improves profitability. Still, other companies have used the proceeds from a sale leaseback to fund a strategic acquisition.
Many manufacturers own their facilities, which makes sale leasebacks a convenient financing instrument. One mental hurdle owners may have is the thought of giving up control of an owned property that is core to the business. However, the long-term lease nature of the sale leaseback provides owners with essentially the same control they have in an owned-facility scenario.
A typical sale leaseback term is generally 15 years (or longer in some cases), with renewals extending for an additional 20 years (at the tenant’s option), providing effective control for 35-40 years. Owners will continue operating the facility as if they owned it.
There are two elements to a sale leaseback transaction – the first being the actual sale of the property and the second being the concurrent entrance into a long-term lease. Many factors are considered in structuring the optimal lease. These include the length of lease, the base rent, as well as the percentage and frequency of rent increases. Also crucial are change of control provisions that do not hinder a future contemplated exit of the business.
Sale Leasebacks in the Industrial Sector
Testimony to the applicability and utility of sale leaseback transactions for manufacturers is that for as long as sale leasebacks have been tracked, almost half of the deals occur in the industrial sector. The industrial sector has been seeing heightened sale leaseback activity for the past couple of years. In the first quarter of 2022, industrial contributed 45 percent of all sale leaseback transactions in the United States, relatively in line with 2021 overall (48 percent), and modestly above 2018-19 levels.
An interesting component of the sale leaseback is the arbitrage opportunity it offers owners of businesses and corporate real estate. In a nutshell, given the value that the sale leaseback can drive due to the lease structure, manufacturers can sell their real estate at an implied multiple that is often greater than the business multiple. Owners can subsequently re-invest the proceeds in corporate assets that have the potential to grow more quickly and generate higher returns.
The table below illustrates this arbitrage across many sectors, but in particular in the manufacturing sector. Per GF Data, the average EBITDA multiple in the manufacturing sector for Q1 ’22 was 7.4x. Based on a general cap rate range of 6.0 percent to 8.0 percent, this implies a multiple on the real estate of 12.5x – 16.7x. As owners are comparing monetization alternatives, they should consider separating the real estate from the operating business to achieve maximum value.
Does Location Matter?
Not entirely. A sale leaseback investor is seeking a safe and steady stream of income from a quality tenant and thus, emphasis is primarily placed on the health of the underlying business. Location certainly comes into play, however, what drives value is the credit strength of the operator.
Given this dynamic, even properties in tertiary or remote markets where manufacturing facilities are typically located command a very attractive valuation. SLB Capital Advisors have executed sale leaseback deals not only in larger metro areas and highly sought-after industrial markets such as Boston, Chicago, and San Diego, but also in markets considered more tertiary such as the Midwest and Southeast.
The first quarter of 2022 continued the torrid pace sale leasebacks experienced in 2021, with 186 discrete transactions totaling $8.4 billion, compared to $8.3 billion in the fourth quarter of 2021 and $2.9 billion in the first quarter of 2021.
Among the real estate categories, industrial properties continued to take the leadership share in the number and dollar volume of sale leaseback transactions. A few of the most noteworthy sale leaseback deals in the past year include New Mountain capital’s acquisition of multiple Rollins buildings for $45M Broadstone’s acquisition of Ryerson properties for $107M, and U.S. Realty’s acquisition of Omnimax facilities for $100M.
New pools of professional capital, an active M&A landscape, and a low interest rate environment, are only some of the reasons for the uptrend in sale leaseback activity in 2021.
With the “multiples” applied to industrial real estate reaching historical levels, a sale leaseback transaction merits consideration. Manufacturing companies in need of financing need look no further and instead consider unlocking the capital that is under the shop floor.
Matt Wrobleski is a Partner at SLB Capital Advisors, which advises corporates and private equity sponsors on a wide range of sale leaseback transactions.