Sale/Leasebacks Offer Solutions in Tight Credit Market.

As corporate credit markets have tightened in recent months, companies are searching for alternative ways to raise capital for growth opportunities as, reduction of high-cost debt or stock repurchase programs. For many, the best source of cash may be all around them--their land, office and industrial real estate assets.

Sale/leaseback transactions have become more common over the past several years as corporate owners and professional real estate investors have become more sophisticated at structuring deals to benefit both buyers and sellers. Today, many investors specialize in single-user properties secured by net leases, and know how to underwrite an asset based on the occupant's credit rating. At the same time, companies increasingly recognize that getting real estate assets off their balance sheets can greatly improve their financial outlook.

That's not to say that companies gain no benefit from real estate ownership. Calculated from a pure real estate perspective, ownership may look like a better alternative than leasing. To truly determine the best course of action, however, companies should run the equation in terms of each alternative's impact on earnings per share overtime.

Corporate executives may think of real estate ownership as a form of investment, and they are correct. The problem is that yields on real estate investment typically fall far below the return hurdles on most companies' operating capital. Consequently, companies are often better off putting the capital to work on their core businesses rather than tied up in real estate.

When business is booming, corporate executives are busy keeping pace with growth and may not have time to analyze the impact of their real estate decisions. When the economy showed signs of slowing and credit markets tightened, financial officers found not only the time to examine real estate strategies but also the need to raise capital for operations.

In the first half of 2001, traditional methods of corporate financing techniques became very difficult as the amount of capital available to the average company declined to less than 30 percent of previous levels. Yet, Wall Street expects companies to show growth in revenues and earnings every year in order for stock prices to increase--and to achieve that growth, companies need access to capital.

When companies have trouble raising capital through stock offerings, they may look next to bond markets. For investment-grade companies, bond financing may be a good way to raise capital, but as companies slip into BB-level credit ratings, the level of proceeds that they can borrow drops substantially.

Like bond underwriters, net-lease property buyers underwrite their investments based on a company's credit rating, but they also take into account the market value of properties. A special-use facility in an out-of-the-way location may have a low value if the current occupant were to leave: consequently, a net-lease buyer would underwrite the property based on the company's credit rating. But a retail property on a desirable corner might fetch a high price regardless of the credit rating of the occupant.

In structuring deals, companies should not lose sight of the operational goals that drive real estate occupancy. To address issues of operational flexibility, sale/leasebacks may be structured with leases of 10 years or less (compared to 20-year lease terms a few years ago), and may provide for sublease rights or even termination rights in some cases.

Companies that turn to their real estate assets for capital may be pleasantly surprised. In one recent example, representatives of CSFB Realty Corp. and parent company Credit Suisse First Boston evaluated options for an established technology firm whose stock value had been battered down to a low $1.5 billion. The company owned a real estate portfolio that was on the books for about $200 million but was actually worth about $800 million on the market for net-leased properties. The difference came from a combination of factors: depreciation for accounting purposes, increases in property values and the value of the company's long-term occupancy. By selling the properties and leasing them from the new owners, the company may capture most of the $600 million difference, equivalent to 40 percent of its total stock value.

In situations such as this one, a sale/leaseback is not a single solution, but a category of alternatives which may be structured in different ways to best meet corporate operational and financial goals. Whether a sale/leaseback is the best execution--and if so, under what terms--will depend on a number of factors, including interest rates, the company's cost of capital, and anticipated property values in 10 or 15 years.

The first step is to make reasonable assumptions and evaluate every viable structure within those assumptions. To get an accurate financial picture, it will be necessary to get banking, investment banking and real estate expertise in a single source that can assess and compare alternatives on the basis of internal rate of return, net present value and earnings per share. Not every real estate service provider can translate the objectives of corporate CFOs into optimal real estate transactions, but those that may help their clients achieve economic operational advantages in leveraging their real estate.

Gary Weiss serves as managing director of tire Los Angeles office of CSFB Really Corp., a Credit Suisse First Boston company with fop real estate professionals in key markets across the country.