In many European countries business owners have long regarded operational real estate with an emotional tie as the “crown jewel” of the company. They’ve tended to view their real estate holdings as core assets not to be spun off and monetized. But the tide is shifting across the pond as European companies, and their private equity owners, realize the arbitrage they can generate by releasing the capital tied up in their real estate and reinvesting it into their operating businesses, where it generates a much higher return. As a result, sale leaseback transactions (SLBs) have been gaining traction in the UK and Europe in recent years. The intrigue from UK and Europe-based private equity firms is strong, this was clear from the turnout from sponsors at the Sale Leaseback Strategies Panel I helped moderate a few weeks ago at the Markets Group Private Equity Europe Forum in London.
At this time about a year ago, W.P. Carey’s head of investments, Gino Sabatini, predicted that we’d likely see an increase in volume of retail SLBs in Europe, “particularly for those essential assets, as US-based investors expand into new markets to take advantage of different costs of capital.”
In many respects, that prediction has come true.
Food retailer, Coop Danmark recently completed a €64 million SLB transaction of 16 grocery stores in Denmark. Earlier this year, Funeral services provider Mémora sold 29 properties in Spain in a €130 million sale leaseback transaction. In the UK, the region’s second-largest grocer Sainsbury’s was in discussions to sell 18 supermarket stores in a £500 million sale leaseback. The deal ultimately fell through, but it gives a sense of how SLBs are becoming more commonplace in Europe.
Currently, European companies’ and private equity firms’ appetite for capital is continuing to grow. This has been driven by a host of factors including traditional M&A activity and a need for working capital. One issue currently is that British debt is getting expensive, and for a compounding effect, lenders are also scaling back on the level of proceeds they’re willing to provide, limiting the borrowing capacity for private equity firms, especially those looking for capital to finance acquisitions. The quarterly Deloitte UK CFO Survey found 56% of chief financial officers at top companies think credit is costly, the most since 2010. 39% of respondents also stated that new credit was not easy to get. "A 12-year period of easy credit conditions is drawing to an end," Ian Stewart, chief economist at Deloitte, said. "Not since the credit crunch have CFOs rated debt - whether that's bank borrowing or corporate bonds - as being less attractive as a source of finance for their businesses than they do today."
Sale leasebacks are a bit of a shining star in today’s global debt markets, and we’ve been seeing robust activity from private equity firms leaning heavily on this financing tool as a means of funding their opco transactions. As Private Equity Wire reported earlier this month, “just $10.6 billion of leveraged loans were raised to fund buyouts by US companies in Q3 – the lowest reading in almost seven years”, according to Leveraged Commentary & Data. “In Europe, it’s possible for GPs to “piece some debt together if it’s below EUR 200m but it’s super expensive and getting above EUR 200m is virtually impossible.”
This set of factors presents a fantastic opportunity for the sale leaseback strategy to make its way into the mainstream in Europe. Lack of awareness seems to be the biggest barrier to wider adoption. Today’s European SLB market is years behind that of the US. It’s similar to the early days of the strategy when sale leasebacks were predominantly used by either distressed companies that really needed the liquidity to survive, or blue-chip companies that were the only ones that knew about this financing tool. It took a while to be adapted into the middle market. Now with private equity firms well-equipped in the sale leaseback world, it’s become much more mainstream.
It’s incumbent on us as SLB aficionados, as well as on middle-market lenders, investment bankers, CPA firms and other business advisors, to educate business owners and private equity firms that they work with on the benefits of the SLB strategy. Middle market advisors and investment bankers in the US know to call out the SLB as a potential “cherry on top” when selling businesses, as a means to generate incremental value for their clients. By contrast, this real estate value creation is rarely mentioned in European CIMs. It’s truly a missed opportunity.
With the increased liquidity need by businesses to bolster balance sheets and make acquisitions in the current environment, SLBs will become more widely adopted. According to Savills Research, European SLB transaction totaled about €9 billion in the most recent year tracked. This represents about one-third of the US SLB transaction volume. The European market is ripe for the strategy though – with about 66% of real estate in Europe being “owner-occupied,” versus approximately 49% of the real estate in the United States.
Differences between European and US SLB market
The regions we’ve been most active in outside of North America are Germany, UK, Netherlands, Czech Republic, Spain, France, and Poland. In terms of asset classes – it’s a lot of retail and grocery, followed by logistics and industrial manufacturing. On the industrial side, it’s important to note that there’s a big spread in Europe in terms of pricing between logistics assets, especially if they’re newer or better located, and specialized manufacturing assets. While the real estate fundamentals are definitely still important in the US, the SLB market in the states predominantly rides on the credit of the underlying operating company. The quality of the real estate typically comes second to the credit concern. Part of the reason for the pricing gap between logistics assets and specialized manufacturing facilities in Europe is that country-specific banks are the primary financing sources in Europe, and they pay much more attention to “fungibility” than do lenders to SLBs in the US. European banks first and foremost want to know that the asset has an alternative use and can be re-leased with an alternative tenant if the current tenant were to vacate.
In the US, this fungibility cuts both ways. SLB investors actually like specialized properties that are heavily invested in, built out for the tenant’s needs, and have expensive equipment bolted to the ground. This makes the tenant “sticky” in this space, and the property “mission-critical” to the operations of the business. As a result, the likelihood of the tenant vacating is very low. Credit and mission-criticality are drivers #1 and #2 factor, with real estate quality being the third.
Conclusion
Often my team feels like SLB missionaries in Europe. There’s no true rationale for SLBs being under-utilized in the UK and Europe. I believe it’s simply an awareness challenge, a knowledge gap. I’ve had many illuminating conversations with private equity firms based in London and across Europe, and the frequent response is “Wow. That actually makes a ton of sense.” But in Europe, many companies still have strong emotional ties to their real estate and there’s a tendency to stay in their lane because “that’s how things have always been done.”
But ask anyone who has ever driven on the Autobahn or Arc Du Triomphe and they’ll tell you if you don’t change lanes once in a while, you won’t survive.
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