Is this the end of the sale and lease back era?

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The last few days have seen a major turnaround in the sale and lease back market with a number of expensive properties falling under the hammer at a fraction of the price at which they were acquired. What seemed in many ways to be a no-brainer has turned into a disaster for many sale and lease back specialists around the world where severe debts have forced fire sales of their most prized assets.

The situation has been pushed to the fore with the news that HSBC has made a £250 million profit buying back its own property which is sold last year the to Spanish property group Metrovacesa for some £1.09 billion. The bizarre thing is that the transaction to acquire HSBC’s office in Canary Wharf was funded by debt from HSBC with Metrovacesa known to have put £280 million of equity into the deal with the additional £810 million provided by HSBC in the form of a bridging loan.

Now that the Spanish group is in severe financial trouble and looking to raise as much money as possible in as short a space of time as possible HSBC has stepped in an 11th hour bid to take back its head office. In effect HSBC has retained the majority of the £280 million in equity provided by the Spanish group and repurchased the property for £838 million.

Sale and lease backs were supposed to be a win-win for both sides with the selling side receiving a lump sum for the property while retaining tenant rights for an agreed period. The purchaser of the property was acquiring an asset which was not only expected to go up in value of but was also backed by a rental agreement, with in this case, a blue-chip company such as HSBC.

So where did it all go wrong?

The main risk with sale and lease back agreements is the movement in the value of the property in question. The seller is risking a potential rise in the future and the buyer is risking a potential fall as we have seen over the last few months. However, in a perfect world the buyer is acquiring a property which is earning income from day one with a watertight rental agreement with a blue-chip tenant. Normally this would be more than enough to cover any short-term fluctuation in property values but the situation we are seeing today is not normal.

It appears that Metrovacesa has overextended itself and with property values falling there may well have been some pressure on banking covenants and a need to recreate a buffer between debts and the overall asset value of the properties in question. Even though the rental figure would have been effectively set in stone the banking covenants would probably have been a major issue and seen a fire sale of the more prominent assets of the group.

When you consider that HSBC sold their headquarters, in what was the largest sale and lease back a deal ever in the UK market, at the top of the market the £250 million “profit” will no doubt assist with cash flow and capital adequacy levels. However, it will be dwarfed by the company’s losses in the property market and potential repossessions in the future.

What is the future for the sale and lease back market?

The commercial sale and lease back market will probably never be the same again with risks appearing over the last few months which many never thought would occur. This will mean that any future sale and lease back agreements will involve a higher risk factor in general and the restrictions and terms will be tighter and more in favour of the buyer. Whether there may well be some form of repurchase agreement added to future deals remains to be seen.

This is a market which many people had deemed to be relatively risk-free with a market rent received in return for acquiring an asset which many expected to increase in value. They would also have been some kind of rental increase agreement attached to the lease which would have protected the future income of the property company involved.

Why have the property companies collapsed?

You would assume that effectively guaranteed rental income would have been more than sufficient to cover the finance costs in the short to medium term, but as we mentioned above, many of these debt funded transactions would have included a covenant whereby the value of the asset attached to the agreement would need to be well in excess of the amount being borrowed. As property values have fallen sharply (with some experts forecasting a 50% fall in the value of commercial properties for the coming decade) this has reduced or in some cases removed the buffer between the amount borrowed and the value of the property pledged against the loan.

Many property companies which are struggling now would have been able to handle a slight reduction in the value of property in the short term but so severe is the current downturn that many business models have literally been blown out of the water. Property companies around the world are falling like flies and company such as HSBC which were either lucky enough or sensible enough to carry out their sale and lease back agreements at the top of the market are in a very strong position.

Conclusion

If nothing else the collapse in the sale and lease back market has brought something of a reality check to a market which many believed was insulated to a great extent. It has however seen many companies with the opportunity to buy back their old assets at severely reduced prices with many property companies desperate for cash flow to finance their debts.

When you consider the number of such transactions over the last decade there may well be many property companies on the verge of having to sell off the “company jewels” to keep themselves in business. This shows once and for all that no area of the property market is safe from the ongoing recession and change in attitude of worldwide banks towards property companies.

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