Investors that have been frustrated by intense competition and a thin supply of for-sale corporate sale-leaseback properties are welcoming a growing pipeline of deals.
Companies ranging from FedEx to Taco Bell typically use sale-leasebacks as a financing mechanism. They pull equity out of their real estate and use that capital to reinvest in their business or finance strategic initiatives such as mergers & acquisitions, expansion or new equipment. However, many companies put such activity on pause due to uncertainty related to the pandemic, which resulted in a drop in sale-leaseback transactions.
According to net lease brokerage firm B+E, the overall size of the single tenant net lease property market is roughly between $7 and $7.5 trillion. In an average year, about $50 billion to $70 billion in those properties trade and sale-leasebacks typically represent about $10 billion of that activity. “We saw sale-leaseback sales that were a bit thinner in 2020, which was definitely a result of COVID. The music stopped, and everyone recalibrated,” says Camille Renshaw, CEO and co-founder of B+E, a net lease investment brokerage firm. “Now in 2021 the music is back on, and everybody is pouring on the gas.”
W.P. Carey is one major firm that has accelerated its buying activity in this space. The company has already acquired some $1.2 billion in net lease assets this year and expects to reach a record high investment volume for the year with many of those deals typically sourced from corporate sale-leasebacks. And the firm has plenty of dry powder to spend. Over the past year the firm has completed both debt and equity raises that have generated substantial interest from investors.
That record volume is being driven by a couple of key factors. One is that the cost of capital, both on the debt and equity side, are near all-time lows. “We’re able to do more and more deals at lower yields that are still accretive to our overall portfolio. So, having that low cost of capital really gives us a lot of flexibility in the types of deals we can do, which is translating into this record high transaction volume,” says Tyler Swann, executive director, investments at W.P. Carey Inc.
A second key driver is demand on the corporate side to do sale-leasebacks. “In the market overall, cap rates are at historical lows right now. I think that has driven more companies into the sale-leaseback market that maybe hadn’t considered it as a financing option in the past,” says Swann.
Restocking the deal pipeline
B+E is seeing its pipeline of potential deals for 2022 grow as companies once again need capital to fund various business strategies. Recent inbound interest at the brokerage firm from corporations exploring sale-leasebacks has jumped 20 percent. As it can take months for companies to lay the groundwork for those deals, Renshaw expects those transactions to hit the market in second or third quarter of 2022.
That growing inventory is good news for a sector that has been battling a shortage of quality deals. A year ago, B+E was tracking about 3,800 net lease properties on the market on any given day and today that number is closer to 2,800. “So, there is a massive delta on how much on-market property there is, and when you look at specific tenants, you see opportunities for very aggressive pricing,” she says. As a result, cap rates have continued to compress over the past year and have hit all-time lows for the most desirable tenants and categories.
There is a lot of capital and pent-up demand from buyers, agrees Aaron Jodka, head of Capital Markets Research at Colliers International. Sale-leasebacks with institutional grade credit tenants and longer term leases of 10, 15 years or longer are seeing cap rates in the 5s—if not lower—in many cases. Best in class properties—top locations with premier tenants—are generating cap rates in the 4s or even sub-4 in some rare cases, notes Jodka.
The return of positive economic growth is giving sellers confidence to move off the sidelines. GDP growth surged to 6.7 percent in second quarter. Although growth slowed in third quarter, economists are expecting that the economy will regain momentum in fourth quarter. Forecasts for 2022 remain bullish with GDP growth expected to remain elevated with various economists predicting growth ranging between 3.5 and 4.5 percent. Another factor feeding the pipeline of sale-leasebacks is record high levels of M&A activity. According to S&P Global Market Intelligence, global M&A activity topped $1.17 trillion in third quarter, marking the fourth consecutive quarter M&A deals have surpassed the $1 trillion mark.
“A lot of what we do at W.P. Carey are sale-leasebacks that are driven by a private equity firm buying a company that owns real estate,” says Swann. Oftentimes, the PE firm will look at a sale-leaseback on the real estate as a way to finance the acquisition. “In their view, it’s more efficient for them to own the operations of the business and unlock the capital that’s tied up in the real estate and go deploy that more efficiently somewhere else,” he says.
Some businesses also are looking to capitalize on a sale-leaseback in 2021 due to potential tax law changes in 2022, adds Jodka. For example, family-owned businesses that are facing potential tax changes related to the elimination or cap on the step-up basis when passing property on to heirs are more motivated to do a sale-leaseback now for wealth management planning.
Pent-up demand for assets
Many buyers are seeing competition for deals that is at or near an all-time high with more capital flowing into the space across the spectrum from institutions and new investment funds to high net worth individuals. “Capital is really coming in from all fronts in this environment where returns on assets are generally low across the board and people see relative value in net lease deals,” says Swann.
Although inventory is noticeably tight in some categories, there continues to be good deal flow coming from sectors that have outperformed during the past 18 months, notably industrial, data centers and life sciences. The robust development pipeline of both spec and build-to-suit projects is creating fresh inventory for sale-leaseback buyers. For example, W.P. Carey recently acquired a 1.5 million-square-foot class-A warehouse and distribution facility in Indiana net leased to an investment-grade leader in the consumer packaged food market for $114 million.
In addition, there are buying opportunities at all price points and for different types of institutional and individual buyers. Other segments that have been on a growth streak are convenience stores and car washes, notes Renshaw. For example, B+E sold a Cloud10 Car Wash in Pennsylvania for $5 million and a cap rate of 6 percent. In addition, there has been an uptick in interest from the QSR sector, especially those that had drive-thrus and thrived during COVID.
“We’re also seeing the market expand with value-add transactions, particularly on the office side,” says Jodka. Office deals with lease risk are now trading whereas that wasn’t happening a year ago, he notes. Office properties, and even some retail buildings, are being purchased by opportunistic investors who might be looking to re-tenant, convert the building to a new use or demolish the existing building once the corporate users vacate and build something new. Sale-leasebacks in tertiary markets are still a tougher sell, particularly on the office side. “For 2022, it will be curious to see whether certain industries drive sale-leasebacks, whether it is the financial industry, tech or another industry, and whether that creates a push from one way or another,” adds Jodka.