Over the course of the past year, we have observed significant developments in the European sale and leaseback market. One point to note is that financial sponsors have matured in both awareness and enthusiasm of the strategy. Reflecting upon this changing landscape, we have identified several key factors that will shape the trajectory of S&LBs in Europe in the coming years.
Accelerated Adoption: We anticipate accelerated adoption of the S&LB strategy based on a growing awareness and evolving perception of the potential use cases. More and more European businesses and investors recognize that this is not merely a tool for distressed companies, which had long been the associated reputation. Rather, S&LBs are being leveraged as a strategic financial instrument for all types of businesses across the size and profitability spectrum. This trend is likely to continue as businesses seek innovative ways to optimize their financial structures.
Strategic Financial Engineering: Companies and sponsors are recognizing that S&LBs offer a unique opportunity to take advantage of strategic financial engineering. S&LBs offer solutions for acquisition financing, present opportunities for capitalizing on multiple arbitrage, and provide access to cost-effective financing without the constraints of financial covenants. Businesses will increasingly incorporate S&LBs into their financial toolbox to unlock value in more varied and creative ways.
For example, there is a trend in Germany of private equity firms acquiring industrial businesses through corporate carveouts from larger conglomerates. These carveout targets often start with challenging financial metrics but hold significant turnaround potential. Private equity firms consider sale and leaseback transactions as part of their acquisition capital stack when other traditional financing sources may be too expensive or unavailable. Alternatively, these sponsors can acquire the real estate at a discount through the carveout then look to complete a sale and leaseback later in their hold period as part of the value creation plan, generating accretive capital that can be used to finance strategic initiatives at the operating company level. This trend is a great example of the adaptability and value creation potential of S&LBs in Europe.
Evolving Debt Landscape: The shifting dynamics of the European debt landscape play a pivotal role in the future of S&LBs. Historically, demand for S&LB as a capital source in Europe was tempered by relatively inexpensive local financing. As these traditional debt sources are becoming more expensive and more restrictive, S&LB financing becomes increasingly attractive from a cost-of-capital perspective.
Unique Tax Considerations: There are unique tax structuring challenges and considerations that come with structuring S&LBs in Europe. Transfer tax rates vary significantly among countries, impacting the transaction cost associated with executing a S&LB in a given market. For example, Belgium and the Netherlands impose relatively high rates at 12.5% and 10.4%, respectively. In contrast, countries like France and Germany have more moderate transfer tax rates, providing better relative economics on a given deal.
This nuance inherently affects the bottom-line for our clients and must be included in the analysis of net impact to the subject company. To mitigate tax leakage, savvy sellers and investors have devised creative structuring techniques, including entity versus asset sales, and long-term ground lease structures versus freehold transactions.
High Owner Occupation Rates: Europe's elevated rates of owner occupation in real estate is a unique factor that will fuel the future growth of S&LBs. Many companies historically viewed their operational real estate as core assets that they “must own.” However, the appeal of unlocking capital from owned properties while retaining operational control is expected to become increasingly compelling. The prospect of maximizing returns on these assets paired with limited or more expensive financing alternatives will drive more businesses toward S&LBs and away from the conservative position that businesses “must own their real estate.”
Private Equity Optimization: Private equity firms in Europe already recognize the arbitrage opportunity offered by S&LBs. However, use of the strategy is expected to evolve further. Private equity firms will continue to optimize their buyout capital structures by strategically incorporating S&LBs, allowing for enhanced returns on investments while maintaining financial flexibility.
In review, the future of European S&LBs is trending toward accelerated adoption. Firms are embracing creative financial engineering as part of their playbook, while the changing debt landscape further drives demand for less expensive financing alternatives. As businesses become more attuned to the potential of S&LBs and seek innovative financing solutions, we anticipate further growth and widespread adoption of this strategy. S&LBs are no longer a fringe strategy but have evolved into a prominent and attractive mainstream financing option for European companies and private equity firms, promising a bright future in the evolving financial landscape.
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