Maximizing Value: Why Corporate Sale-Leasebacks Are a Win-Win for Investors, Occupiers

By Samantha Goldberg

Faced with uncertainty regarding interest rates, tax reform and other critical issues, investors are looking to take advantage of the current low interest-rate environment and deploy capital. The net lease sector is one area investors are flocking to, particularly corporate sale-leasebacks. The potential for consistent, long-term returns without the responsibility of day-to-day operations offers proven appeal; meanwhile, corporate executives can pull capital out of real estate and invest it elsewhere while the firm continues to occupy the space it needs. With these benefits to both buyers and sellers, corporate sale-leaseback opportunities are not keeping pace with investor demand, creating optimal conditions for prime assets to command high prices.

“The market is in a much better spot than it was five to 10 years ago. … That’s creating an opportunity for higher valuations of assets for companies like us to unlock value,” noted Michael Huaco, senior vice president of corporate real estate for McKesson Corp. Earlier this year, the pharmaceutical company sold One Post St., its nearly 500,000-square-foot headquarters in San Francisco’s financial district, to Brookfield Properties for $245 million. McKesson cut its footprint by more than half, now leasing 200,000 square feet from the new owner.

With asset values rising over the past two years, Huaco noted, corporations are increasingly evaluating their owned real estate and determining whether they can put the equity in those holdings to better use.

Risk removal

In addition to freeing capital, sale-leasebacks help corporations to manage risk and hand over responsibility for an asset to willing investors who are experienced with adding value.

The Great Recession offered a dramatic reminder that owning real estate can be risky, so corporate occupants deciding how to mitigate that risk “need to think about their real estate as part of their capital structure … particularly if their real estate is material to their balance sheet,” said Shan Gastineau, senior director at Stan Johnson Co.

Today’s low cap-rate environment also makes for a good seller’s market, meaning corporations may have a stronger position in lease negotiations, said CBRE Corporate Capital Markets Senior Managing Director Brian Scott. Typical sale-leasebacks have 10-, 15- or 20-year terms with annual 1 to 2 percent rent increases, Scott noted, but credit tenants selling high-quality assets may be able to negotiate shorter terms, smaller increases or transference of some capital expenses to the new owner.

“We’re advising companies that if they’re thinking about doing a sale-leaseback and it makes sense for them, now is an outstanding time to do that as far as maximizing value,” he said.

Fundamental factors

While corporate sale-leasebacks remain appealing, investors are becoming more discerning in the types of assets they acquire. “Corporate sale-leasebacks are probably going to become more and more difficult to do, but they still have some appeal,” Gastineau said. “When it comes to a corporate sale-leaseback, the real estate matters a whole lot, and the credit of the (corporate tenant).”

An investment-grade tenant with a long-term lease is certainly desirable, but an asset located in a suburban environment could pose more of a challenge for investors. This is especially true for larger assets like headquarters, which carry greater vacancy risk.

“Often, that headquarters is the dominant piece of real estate in that environment,” Gastineau explained. “An investor has to decide, ‘Can I lease this out over the next X number of years, and will I have success at that?’ So it becomes a real underwriting headache to try and decide whether they can be successful at backfilling any vacant space.”

Beyond the lease

Vacancy risk is becoming increasingly important in the sale-leaseback space, especially in today’s climate of rapid technological advancements and demographic shifts. Corporations’ strategies and space needs are changing faster than ever, leading both investors and buyers to consider the need for flexibility in lease terms.

As a result, sale-leasebacks are often a partnership of owner and occupant, rather than a simple matter of rent collection. For McKesson, the larger goal of its deal with Brookfield was to establish a long-term relationship that laid the groundwork for similar sale-leasebacks around the country, Huaco said, allowing the investor to grow in core markets and McKesson to sell underutilized assets.

Partial sale-leasebacks like the McKesson deal are becoming more common, largely due to a shift in how corporations use office space.

According to CBRE’s 2017 Occupier Survey, 87 percent of respondents said they were disposing of surplus space and/or implementing a more efficient workplace design to rightsize their portfolios.

“These big office corporate campuses or headquarters don’t necessarily have (fewer) employees, but they certainly have less need for office space than they did before,” said Gastineau, noting that space allocation has declined from 350 square feet per employee at its peak to about 150 square feet.

Health care giant McKesson Corp. sold its San Francisco headquarters at 1 Post St., to Brookfield Properties for $245 million in April 2017. The firm leased back 200,000 square feet of the nearly 500,000-square-foot tower.

Another motivation for sale-leasebacks: Unless corporate occupants are using all of their space, they’ll effectively have to become landlords and sublease the surplus, which usually “is not a palatable solution,” he added. As a result, many corporations are looking to offload the vacancy risk to a new owner.

In McKesson’s case, the firm pursued a sale-leaseback for its San Francisco headquarters as part of its larger strategy of right-sizing its assets. The firm needed only 50 to 60 percent the space, and the transaction provided “the flexibility in a new lease structure to grow and expand and contract” as the business requires, Huaco said.

Gastineau predicts that the partial sale-leaseback trend will continue to grow while conventional full-property sale-leasebacks will likely decline. The data seems to indicate this trend as well. In the office sector, partial sale-leasebacks grew from $275 million in the first quarter of 2016 to $1.3 billion in the first quarter of this year, according to Real Capital Analytics data. Conversely, full sale-leasebacks dipped from $435 million to $288 million over the same time period.

“As the market gets accustomed to (the partial sale-leaseback), they’ll become comfortable with it and the market investment community will bid on it,” he said. But Gastineau warned that some investors—particularly REITs—are beginning to shy away from office assets, largely because of the shift in corporations’ need for space. Instead, REITs are finding attractive opportunities in the industrial sector, where demand from tenants is growing, thanks primarily to the rise of e-commerce.

“That’s been happening for the last 18-24 months and I don’t see any signs of that changing. Yes, it’s an attractive time for sale-leasebacks, but it’s going to become less so at some point for office.”

Above images by Reflex Imaging Inc., Courtesy of McKesson Corp.

Originally appearing in the November 2017 issue of CPE.