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Getting Bricks Off the Books

The U.K. company headquarters of the venerable American institution, Pleasantville, NY-based Reader’s Digest, sits at 11 Westferry Circus in Canary …

The U.K. company headquarters of the venerable American institution, Pleasantville, NY-based Reader’s Digest, sits at 11 Westferry Circus in Canary Wharf, a massive office aggregation, most of which has only been built over the last decade, in London’s Dockland section of the city.

The Reader’s Digest Association occupies 140,000 square feet of a building it had developed at the western gateway to Canary Wharf. The company used to own it as well, but in January 1999, it concluded a successful sale leaseback agreement, whereby it sold the building to DIFA, one of Germany’s largest open-ended real estate funds, and in return, took a long-term lease to occupy two-thirds of the buildings.

According to Reader’s Digest financial statements, the building was sold for $97 million and, of that sale price, approximately $13 million was placed in escrow at the time of closing and approximately $4 million was used for costs incurred in connection with sale. The gain was recognized on a straight-line basis over the term of the lease.

The sale was part of a general strategy by chairman and CEO Tom Ryder to realize value from non-core assets while trying to position the company for growth.

Companies that own a lot of real estate and carry it on their books, usually do so at a low basis, earning no return, says Michael Alter, president of Chicago-based developer, The Alter Group. “Businesses can make better use of that money. One option is to do a sale leaseback, take the money out, reinvest in the business, and generate a good return. They don’t need to be in the real estate business and might as well let a third party deal with property issues.”

As Corporate America continues to focus on core strategies, the trend to sell off real estate holdings then lease-back the space as it is needed has accelerated.

The practice has always been very common for large retailers and fast food companies-these stores are rarely owned by the corporate parent-but less so for the old economy companies involved in manufacturing and service businesses.

In the mid-1990s, a form of sale leaseback called the synthetic lease became popular with Silicon Valley companies, such as Advanced Micro Devices, Applied Materials and Cisco Systems. Basically, the synthetic lease used a special-purpose corporation (which takes the real estate off-balance sheet) to own the facility, while the company pays rent on the facility equal to the current monthly interest charges. Although synthetic leases are still in use, there has been a shift back to basic sale leaseback agreements in the high-tech world. Over the past few years, among the high-tech firms doing sale leasebacks were TeleVideo for its San Jose headquarters and Techniclone for its Tustin, CA, home office.

With a lease, a company can control and inhabit properties without actually owning. In a sale leaseback, the property owner sells the real estate to an unrelated third party and then enters into a lease for the property. Typically, the lessee enters into a net lease for a long period of time, often consistent with the term of the mortgage loan. Net leases can come in a variety packages, such as single net, double net or triple net. These variations are based on which party gets to pay for taxes (single net), insurance (double), and maintenance (triple).

Sale leasebacks and build-to-suits have also gained favor recently because it has become more difficult for small-and medium-sized companies to pencil out deals. A million- dollar building two years ago might have meant a 10 percent equity requirement, but the lending community has tightened up so a company today might have to come up with 20-to-25 percent equity to gets its loan-and then there are the higher interest rates.

Buyers of sales leasebacks are not difficult to find. Besides a host of institutional investors looking to bulk up portfolios, some companies specialize in these acquisitions. Lexington Corporate Properties Trust, a New York-based REIT, for example, provides real estate financing services to corporations and builders principally through sale leaseback transactions and the acquisition of single tenant net leased build-to-suit properties.

While companies need more space because of the strong economy,” ‘says Richard Rouse, co-CEO of Lexington Properties, “at the same time, more and more firms are focusing on return on assets and one way to increase return on assets is to decrease the capital tied up in real estate.”

Of course, that’s not the only way to increase return, but for those firms wanting to make the most of their assets, it’s certainly one strategy worth looking into.

Steve Bergsman is a Mesa, AZ-based freelance business writer who has written about corporate finance for Reuters, Barron’s, Global Finance and Corporate Finance. 

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