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Raising capital from real estate

Selling the family silver to fund the business is not for everyone

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There are lots of corporates with billions of owned property who would never consider a sale and leaseback – they are usually financially strong, have access to corporate debt at rates around 2 to 3 percent and do not want to sell off their core property to raise capital at a higher cost.

Others have taken a different view; J Sainsbury’s and Tesco in particular. They have actively recycled capital from core properties in their portfolio to satisfy their appetite for funds to extend and develop new stores. They have used their property portfolio as an alternative source of capital to equity and debt, at a relatively low cost – in some cases at rates between 5 to 6 percent, with the additional benefit that in most cases it has been off balance sheet.

They have also been creative in how they have structured property transactions. Demand from investors has fuelled innovation and there are now a whole range of options available to corporates for raising capital from their property. Strip income, fixed income, commercial mortgage and property fund investment products mean corporates have more choices to consider other than just the plain vanilla sale and leaseback.

Whatever the choice; the lowest cost of capital is available to investment grade corporates (BBB- or better) who are prepared to sign long leases with RPI uplifts. There is an overwhelming demand for this type of product, especially from annuity funds seeking to match assets to their pension fund liabilities. The pricing is particularly keen for properties where the residual value risk is low, like large supermarket sites or prime office buildings in Central London; but of course, not all properties fit that bill.

One way corporates may remove the residual value risk for investors can be by selling “strip income” investments. In this case, the sale and leaseback is structured with the corporate selling  a 20 year lease interest (typically the minimum term required) to the investor for a premium, in return for the corporate signing a 20 year occupational lease. This way the corporate retains the freehold interest and provided the lease is indexed, the investor has a bond style investment which they are able to price much more keenly. So it’s like a bond, but it’s not a bond.

A process called securitisation takes this a stage further by using the lease income stream to actually create a bond. In this case, a special purpose vehicle (SPV) is created which issues the bonds, the proceeds of which flow through to the corporate. The bonds are repaid from the income stream from the long indexed lease to the corporate, fully amortising over the lease term and are secured on the asset.

The bonds attract fixed income investors more interested in the quality of the income stream rather than the nature of the property. This can provide very competitive pricing which is usually at a small margin (say 75 to 100 basis points) over comparable length bonds for the same company: a cheaper cost of capital than a typical sale and leaseback plus it can work for property that has no conventional market.

Securitisation issues have typically been carried out for large property transactions, in excess of £100 million where the bonds are publicly traded instruments. But they don’t to need be large or publicly traded. A private placement market exists of "fixed-income" investors, especially US Pension Funds and Insurance Companies, who are just as willing to invest in £10 million transactions unlisted and unrated transactions.


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