Understanding property sale leasebacks

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If a business has pressing capital needs, a reprieve may lie in a common transaction that every executive has heard of but may have not paid close attention to: a sale leaseback, or SLB. At its core, an SLB is the sale of your manufacturing facility and then a simultaneous “leaseback” to you of the property from the new owner.

Selling the facility to an investor and leasing it back simultaneously can free up capital that can be reinvested in purposes more relevant to the core mission of the business, including new product development, equipment purchases, and IT investments. Some manufacturing companies even use the proceeds to pay down debt and bring more profit to the bottom line.

These transactions can be complex, but that is also one of their advantages because they can be uniquely tailored to any manufacturer’s bespoke circumstances.

Industrial Property Is Hot

While SLBs always have been worth considering, for manufacturing companies, they are particularly worth evaluating in today’s market. For a variety of reasons, industrial properties are highly attractive assets, and a manufacturer might be able to sell their property at a value they might not be able to realize for quite some time.

Letting go of ownership can be tough for some, but a long-term lease of 15 to 20 years with multiple five- or 10-year renewals provides you with effective control over the asset for upwards of 35 to 40 years.

Further, the more crucial the property is to the operations of the company, the more value the manufacturer can gain from the transaction.

SLBs in Industry

The value of metal manufacturing companies has been growing steadily because of the increasing demand for metal and metal-manufactured products caused by supply disruptions, infrastructure spending, and, albeit unsteady, economic expansion.

And while companies have recognized how to capitalize on this value through SLBs, many still are unaware of this strategic financing tool.

We recently advised a specialty metal manufacturing company in the SLB of its only facility. Based in a tertiary market in New England, the property, which was constructed in stages over 100 years, was sold for more than US$15 million, significantly exceeding the company’s bank appraisal. Proceeds from the transaction allowed the company to enter 2022 with no debt and with significant working capital for investments. It even facilitated a buyout of a minority shareholder.

Value Arbitrage Opportunity

SLBs offer metal manufacturers a unique arbitrage opportunity [the practice of taking advantage of different prices in different markets] because of the current premium valuation of industrial real estate when compared to traditional transaction multiples in real estate. This difference allows manufacturers to cash out of real estate at high prices to reinvest in their business and fuel growth in their core operations.

Depending on the underlying performance of the business, an SLB is executed on the underlying real estate at a range of approximately 13 to 18 times its operating income. For companies sitting on industrial real estate, its sale can command several millions for growth capital compared to a mid-to-high, single-digit multiple seen in a typical industrial business.

To structure an optimal SLB, sellers should look at various factors, including the lease structure and length.

The base rent, as well as the percentage and frequency of rent increases, also come into play. For many parties, it also is crucial to negotiate a change of control provisions that do not hinder a future exit or sale of the business.

Not Just for Top Markets

Manufacturers with properties in remote areas may wonder if location can affect its value. After all, a premium location, such as a large metropolitan area, typically suggests better pricing when it comes to real estate transactions.

However, while real estate fundamentals such as location do play a role in valuation, an SLB differs because of the priority of the SLB investor, who prefer a tenant with strong credit and a safe and steady income stream. Therefore, SLBs are effective even in what may be considered a tertiary market.

Investors definitely factor in real estate fundamentals into their evaluation process, but these fundamentals are in some ways detached from the “rules of the road” that govern a traditional real estate transaction. We have performed these transactions, not only in highly sought-after industrial markets such as Boston and San Diego, but also in tertiary and rural areas in North America because of this unique dynamic.

In terms of Canadian sale leasebacks, in February 2021, Cube Plastics executed a $19 million SLB on its 170,000- sq.-ft. Aurora, Ont., facility with a subsidiary of Effort Trust. And Metalumen, Guelph, Ont., executed a $9 million SLB on its 93,000-sq.-ft. facility in May 2021. Cottam Diecasting Ltd., Tecumseh, Ont., also executed a $5 million SLB on its 75,000-sq.-ft. facility in October 2021.

The Market Remains Strong

SLBs definitely had a resurgence in 2021. Seven hundred and ninety deals were closed raising US$24.3 billion—a near-record year in terms of deal value and transaction volume. Industrial SLBs constituted 48 per cent of deals in 2021, including manufacturing, distribution, and warehousing.

This uptrend typically is attributed to the active merger and acquisition landscape, a low interest rate environment, and new pools of professional capital moving into the SLB space.

With the incredibly high valuations of industrial real estate in today’s market, an SLB transaction is worthy of consideration. For many metal manufacturing companies, there may be an opportunity to tap into the capital under the shop floor.

Stephen Cheng is partner at SLB Capital Advisors, 121 Varick Street, 8th Floor, New York, N.Y. 10013, 646-762-0129, www.slbcapitaladvisors.com.