Real Estate Optimization in the M&A Process
How to create value when a sale-leaseback is not an immediate opportunity
When a private equity firm buys a business, it considers labor rationalization, economies of scale and cost reduction. But PE sponsors often overlook lucrative options related to real estate, particularly when a sale-leaseback opportunity isn’t immediately apparent.
Sponsors have become more broadly informed over the last several years of the benefits of a sale-leaseback, in which a company sells its real estate and signs a lease for use of the property. These can be highly accretive transactions that occur simultaneously with an acquisition.
Yet when a sale-leaseback is not an option, sponsors don’t always pursue other opportunities.
“I do think looking critically for value in leased real estate is underutilized,” says Edward Otocka, senior managing director, private equity specialist at New York-based net lease investment advisory firm STNL Advisors. “Most conversations are around a sale-leaseback when the business seller also wants to sell his or her real estate, so I believe there is a lack of awareness.”
Consider All the Angles
Looking critically for value in leased real estate is underutilized
For various reasons, a sale-leaseback arrangement isn’t always an option. A business owner might not want to sell the property, for example, or the real estate might be owned by a third party. In such cases, sponsors may negotiate a deal that doesn’t look at all the angles.
For instance, if a sponsor signs a lease with the property owner, it can materially increase the property’s value. The value of the real estate is highly impacted by factors like lease term, base rent, tenant credit and whether the tenant is sponsor-owned. Without fully understanding how the lease negotiation impacts property value, PE firms can forfeit millions of dollars of value.
“We work with the sponsor to assess what the property was worth pre-acquisition, and what it would be worth as we near the end of the lease negotiation,” Otocka says. “A sponsor can often enhance asset value by 2x through their acquisition, and they should be participating in this value creation, whether that’s a profit share if the real estate is sold, or through some other means.”
Another common missed opportunity comes during lease negotiation. By analyzing local market rents, vacancy rates, new developments and other factors, a partner like STNL Advisors can assess the cost of rent and determine whether it’s best to relocate to a less expensive facility. The sponsor can either move the company or, more often, negotiate lower rent, often at a 15%-40% reduction.
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In other cases where a sale-leaseback isn’t an immediate option, it may be possible to negotiate for it to occur at a later date.
For example, if a business seller wants to sell the real estate, but the tenant cannot afford rent payments at market rates, the sponsor can look at putting a purchase option in the lease. If the sponsor improves the business, it can exercise the option in the future and execute a sale-leaseback transaction.
Regardless of the circumstance, having a trusted partner that understands real estate nuances can help ensure sponsors maximize value in the deal.
“The best practice is to hire an advisor who is an expert in this area, so he or she can look at real estate every time private equity sponsors buy a company,” Otocka says. “That way, private equity sponsors will know if there is potential actionable value or not.”