David Lawson – Financial Times 2002
Until recently, real estate rarely rated a mention in the boardroom. Directors had no idea what they owned, let alone what it was worth. Today few finance directors will not have closely studied of the firm’s bricks and mortar with the idea of raising capital.
Trapped between demands for increasing shareholder value and the difficulty of increasing returns in a low-inflation environment, they are keen to emulate public bodies and leading companies which have been tapping this source. But lack of experience has left widespread misunderstanding of the benefits and drawbacks.
Sale and leaseback is not new but these pacts between occupier and investor have changed. In the past they tended to include buy-back provisions at the end of the lease, according to Olivier Piani, managing director of Paris-based GE Capital UIS. In other words, they were simply an alternative to long-term bank loans. Today, occupiers are pretty well washing their hands of the property. The 321m Euro purchase of 11 airport-related properties from SAS by GE Capital Real Estate and Nordisk Renting still contains buyback options but they lie within the period of the contract as a kind of fallback insurance.
The real break with tradition, however, has been extension into ‘total outsourcing’ under which other services are also contracted out. These go beyond fund raising, aiming to shuck off incidental activities and concentrate on core business. They also offer measures like benchmarking to compare efficiency with competitors.
These moves to spin off real estate were given an added boost when a study last year by London’s City Business School showed that companies with a predominance of leasehold property ‘significantly outperform’ those owning freeholds. And there is plenty of scope, when 67% of property across Europe is owned by occupiers and public bodies compared with less than a quarter in the US, says Tony Edgley of Jones Lang LaSalle Corporate Finance.
But outsourcing has been slow to take off and occupiers are experimenting with exactly what they want from investors. In the UK, for instance, the BBC’s deal with Land Securities Trillium, Britain’s biggest real estate group, includes development rights, capital works and facilities management as part of a range of services. British Telecom’s £2.38bn property transfer to Telereal, a consortium of LS Trillium and Pears Group, opted out of those services but included asset management and terms allowing flexible occupation.
Mapeley, the George Soros backed group added property management to its sale and leaseback deal with Abbey National, the leading UK bank. Most impending deals lie closer to this end of the spectrum, says Edgley. ‘Sale and leaseback is easy for a board to understand,’ he says. More extensive outsourcing can also have hidden pitfalls.
‘One company which wanted to be seen by investors as raising money pulled back when it realized that it had different provisions for services in each European country, says Giles Ballin of real estate consultant Strutt & Parker.
Even sale and leaseback is not as straightforward as some expect. Occupiers looking beyond fund raising to greater flexibility through shorter leases should realize they will not get the same price from investors as for conventional long leases, says Edgley. Some sophisticated firms are happy to make this trade . Microsoft won staggered break provisions on the first phase of its UK headquarters as part of the £100m sale to British Land and a US pension fund organized by Strutt & Parker.
Manufacturers face the biggest problems, as the specialized nature of factories make them unsuitable for outsourcing, says Piani. But many retail and warehousing groups – and even some office users - may have to tone down their ambitions because so much property is not up to the standards investors demand, says Edgley
This is one reason why outsourcing has been so slow to take off. Another is sheer lack of suitable investors, he says. The $13 billion US investors have earmarked for Europe is medium-term capital, unsuitable for leasebacks. Total outsourcing is even more constricted. Mapeley hopes to fill the void by expanding into mainland Europe but chief executive Robin Priest says he would welcome competition. Otherwise potential customers might feel they were not being given a choice, and refuse to play altogether.
Such reluctance is not necessarily a bad thing, according to Alan White, who sold off BT’s property before becoming an advisor with international consultant DTZ Pieda. It might give companies pause to realise that outsourcing should fit a strategic business plan rather than just be considered a pot of extra cash.
Too often they fail to realize how this can tie the hands of operational managers, who may become locked into unsuitable real estate. ‘There is always the danger that the wishes of occupier and investor will get out of line,’ he says.