You can only sell the crown jewels once - it’s an oft-repeated phrase in the investment community when the subject of retail sale and leasebacks crops up.
Many experts use it to explain why there have been so few sale-and-leaseback deals of late - their point being that so many retailers have gone down the route in the past decade, there aren’t many operators left who could take advantage of this financing option.
This, coupled with the potential introduction of controversial new accounting standards by 2018 as part of a crackdown on the use of leasing to raise finance off the balance sheet, would certainly seem to have put paid to the volume of deals we saw back in 2010-11, when the grocery multiples released tranche after tranche of stores onto the market to help fund their ambitious expansion plans.
But does it mean we’ve seen the back of sale and leasebacks for good?
The future certainly doesn’t look bright. As the graph overleaf reveals, the number of sale-and-leaseback deals has fallen dramatically in the past 18 months or so. If the trend continues, it could signal the beginning of the end of a decade-plus-long trend. The first significant tranche of retail sale-and-leaseback deals in the UK were done between 2000 and 2005 when the likes of Kingfisher, Debenhams, Marks & Spencer and Boots put hundreds of stores up for grabs that were greedily snapped up by investors.
The next large series of chunky deals started to hit the market towards the end of the same decade when the grocery multiples - particularly Sainsbury’s and Tesco - used the sale-and-leaseback model as a way of financing their respective land grabs at the height of the space race.
According to one investment expert, their view at the time was “if they could do a sale and leaseback on a single store for £50m, they could probably open two new stores with the proceeds that would be worth about £50m and they would own those on a freehold basis, so it was all about reinvesting the capital in the property estate to grow”.
However, thanks largely to the rapid rise of the discounters during the recession and the frenzied price war that ensued among the big four grocery multiples, they are not growing any more and their needs have changed, with sale and leasebacks taking a back seat, says Tom Edson, investment director in JLL’s out-of-town retail food stores team.
“The requirement for capital is less than it was five years ago. The space race is not what it was and the demand to recycle that capital throughout the business to get those new stores opened is a fraction of what it once was,” he says.
It’s a view shared by Knight Frank partner Richard Petyt, formerly of Asda’s property acquisitions team, who adds that in this new era of grocery retail, where the discounters are increasingly holding sway, the perception among the multiple operators in particular is that they’re better off owning their stores to ensure they don’t have problems with rental uplifts, as a result of the RPI- or CPI-linked rent reviews that are typically inserted into sale-and-leaseback deals, further down the line.
“They want to retain control of their business and their assets,” says Petyt. “In the past, they may have done some sale and leasebacks where they entered into arrangements where the rental is going to grow faster than the projected turnover will, so they’ve put themselves into situations where they have got decreasing profitability in stores and they don’t want that to happen again because they are nervous about how their store trade is going to grow over the next few years.”
Another reason hardly any sale-and-leaseback packages are coming to market is few high-street retailers actually own and operate large freehold estates nowadays. The grocery multiples, in particular, have far fewer freeholds, having pumped so many into the market over the last decade - for instance, Tesco owns just 53% of its store portfolio.
As Jerry Burton, senior director at Bilfinger GVA, explains: “A lot of retailers have already sold the family jewels; there aren’t many left who could go down this route. Then you’ve got a lot of retailers who want to hold the freeholds that they own. You’ve also got retailers who just don’t have a good enough portfolio to put to market.”
Investor appetite is also partly to blame for the dearth of deals, with pricing not as keen as it was a couple of years ago, adds Colliers’ head of retail investment James Watson. “The market overspent on them,” he says. “There’s not a lot of money around for Tesco sale and leasebacks now because its covenant is saturated throughout the market in terms of institutional ownership. If Sainsbury’s wanted to do some more there would be some demand for it, but the pricing would be lower than it has achieved previously.”
Marcus Wood, director, retail capital markets at DTZ, agrees. “This is as much a case of investors looking at their books and asking how much more of a specific covenant they can carry as it is whether or not it’s suitable for the retailers to keep progressing down the sale-and-leaseback line,” he notes.
“If I look at the investor end of the telescope and ask, ‘is there still demand for top-quality covenants on long indexed leases where they don’t already have an oversupply of that particular covenant’, the answer is definitely yes. But they don’t want more of the same covenant that has been sold over the past five or six years.”
The final nail in the coffin could be the looming new accounting standards proposed by the International Accounting Standards Board (IASB). The standards, which have been in the pipeline for a few years, will be published later this year and are expected to be introduced by 2018.
When they come into force, leases - which are currently accounted for only as operating expenses on the profit-and-loss account, meaning they have no impact on debt levels or gearing - will come onto company balance sheets as both an asset and liability. The changes will have a “fundamental impact” on sale and leasebacks and make these deals less appealing for retailers, believes John Taylor, associate partner, Real Estate Advisory, at KPMG.
“If a retailer was committed to paying a rent of £100,000 a year over 10 years, under the new accounting rules that £100,000 x 10 years would be a £1m liability, or debt, on the balance sheet,” he says. “That would be discounted, but for retailers with considerable leased portfolios those are significant sums,” says Taylor.
As a result of these changes, it’s highly likely that retailers will start to look more closely at alternative forms of funding, such as REIT structures, short-term securitisation deals and joint ventures.
Sale and leasebacks will continue to be the correct option in certain circumstances - Richard Dean, CBRE
This does not necesssarily signal the end of sale and leasebacks, however, says GVA’s Burton, who believes there is still an appetite for certain types of property. “On the c-store side, there is still some very good demand out there for it, especially if they come with a collar and cap in terms of guaranteed growth - either RPI or CPI,” he points out.
Investors are also keen to dig their claws into the discounter groups that have not yet explored the sale-and-leaseback option, despite having significant freeholdings, and need cash to fund their aggressive expansion plans. However, one source says that a member of Aldi’s property team recently categorically stated it wouldn’t consider using sale and leasebacks and it is understood that Lidl has adopted the same stance. Additionally, both retailers are increasingly snapping up leasehold deals to secure sites, whereas in the early days of their expansion they were typically on the lookout for freehold opportunities.
Where there is more likely to be some movement is for historical deals - those completed in the past decade or so that may start to change hands as investors shuffle their portfolios around. “Because billions of pounds of product was put into the market over the last five years, we’ve seen the creation of a new submarket where these things will increasingly get sold on,” says JLL’s Edson.
Then there’s the slightly more remote prospect of retailers invoking buyback clauses, or reverse sale and leasebacks. According to sources, Tesco inserted buyback clauses after five years, so earlier this year, when the retailer completed a £733m property swap with British Land as part of an effort to reduce its eye-watering £1.4bn annual rent bill, some investment experts speculated that this might signal the start of a new property strategy for the grocery multiple, which has a number of buyback options due to come through in 2015-16.
However, most members of the investment community believe that unless a deal is put on the table that’s too good to be true - or fits with a new strategic direction - it’s highly unlikely many of these clauses, if any, will be initiated as the grocers would struggle to find the funds to finance the buybacks.
It’s also unlikely that any of the expanding retail operators, such as the pound-store groups, variety discounters, or the pet store or furniture groups building a presence largely through leasehold deals on out-of-town retail parks, will ever build up a significant enough war chest of freeholds to bring to market. However, while a return to the levels of activity seen a few years ago is probably not on the cards, Richard Dean, senior director in the EMEA corporate strategies team at CBRE, agrees with GVA’s Burton that there will still be some demand and suggests we could well see an uplift on current levels.
“With increased consumer confidence and a more resilient retail sector, future volumes are likely to increase,” he says. “Sale and leasebacks will continue to be the correct option in certain circumstances, whether long-term capital raising or more tactical shorter-term leases to realign the portfolio.”
So perhaps the retail sale-and-leaseback deal isn’t dead after all… it’s just resting.