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U.S. SALE-LEASEBACK MARKET ATTRACTS FOREIGN CAPITAL

By Michael Fickes

Sale-leaseback transactions are surging in the U.S., and sources say brokers and investors are seeking deals overseas and working with non-investment-grade retailers to keep up the pace.

The volume of sale-leaseback deals, which involve a tenant’s selling its real estate and then leasing that space back, has risen from $322 million in 2003 to just over $1 billion through June 1. “Looks like we’re on pace for a record that might blow away last year’s figures,” said Dan Fasulo, director of market analysis at New York City-based data provider Real Capital Analytics.

In fact, the sector is so popular that traditional brokers and investors, priced out by low cap rates, are willing to look at riskier retailers. As a rule, sale-leaseback providers prefer to do business with investment-grade retailers. Four years ago, for example, Orlando, Fla.-based National Retail Properties (formerly Commercial Net Lease Realty) regularly did sale-leasebacks with Best Buy. “We were doing Best Buy deals at 10 percent cap rates,” said Joe Ciardiello, senior vice president of acquisitions at National Retail. “Today you can’t touch a Best Buy deal for better than 6 percent. So we have moved into the sub-investment-grade market. In particular, we’ve been buying franchise locations from restaurants like Taco Bell.”

Taco Bell and similar borrowers with low credit scores have become more active in sale-leasebacks mainly because they have few other alternatives for raising cash, observers say. “Over the past three years, we have seen an inordinate number of sub-investment-grade retailers doing sale-leasebacks,” said Bruce MacDonald, president of Net Lease Capital Advisors, a Boston advisory firm that structures real estate strategies for businesses. “Sub-investment-grade companies have taken advantage of this period of high real estate prices and realized much more than they would have previously. But this period de-motivated investment-grade credits, because they could borrow based on their credit.”

Even as U.S. cap rates fall, more sale-leaseback opportunities have opened up in Europe’s mature markets, where many chains are just recognizing the benefits of selling off valuable real estate to focus on their retail operations. W.P. Carey, a New York City-based sale-leaseback provider, has taken a lot of its business outside the U.S. “We’ve seen a steady decline in domestic sale-leaseback deals because of what we see as unreasonable risk-return trade-offs,” said Ben Harris, a managing director at the firm. Germany is a particularly lucrative destination, Harris says.

W.P. Carey carried out 28 sale-leasebacks totaling $865 million last year. About half of those funds went to purchase international properties. “Our peak domestic year was 2002,” said Harris. “Our domestic volume in 2005 was half of 2002. Our total volume has remained the same, because we have allocated more money to foreign investments.”

Now that interest rates are due for a rise, the sale-leaseback playing field will probably reshuffle considerably, sources say. Investment-grade retailers are likely to return to the sale-leaseback market as short-term rates go up and the gap with long-term rates closes, according to Harris. At the same time, the sub-investment side will continue to find sale-leasebacks to be their most economical capital source. Even so, “they’ll probably see lower prices for their property and pay a little more in rent,” Harris said. As for the investment-grade ones, they will return once long-term rates improve.