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Sale & leaseback transactions

publication date: Oct 17, 2006
author/source: Felix Rigg
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At our 19th September auction in London, the first lot offered was a double-fronted estate agency in Whaley Bridge’s Market Street. Let for fifteen years to a Derbyshire estate agency chain, the property sold for £368,000. For the buyer, the purchase will provide him from the outset with a net initial yield of 7.26%.

A little later, another branch of the same estate agency – this time in Chapel En Le Frith – sold under my hammer for £129,000 - a net initial yield of 6.07%. The letting was on more or less identical terms, save for the precise level of rent to be payable by the agent in each instance.

What may not be immediately apparent was that both of these were “sale and leaseback” transactions. Whilst these have become quite common over the last decade, it is more usual to see sale and leasebacks from elsewhere in the High Street. Properties offered on behalf of HSBC, Barclays, Lloyds TSB, Unwins (before they went into liquidation), Thresher, Martin McColl, Wine Cellar, Somerfield and HSS have all featured extensively in auction catalogues during this period.

So what is a “sale and leaseback”?

The general idea is that anyone owning the freehold (or long leasehold) of the building they occupy may offer the property to the market on a sale and leaseback basis. In simple terms, the seller becomes the tenant at the moment the sale of the property completes and thus continues to trade from the property. The buyer then becomes his landlord.

Clearly, the main point of any property investment is that the owner can expect to receive an income, in the form of rent, from the tenant. Naturally, the reciprocal relationship of risk and return applies here just as it applies to any investment: a news agency let to Mr Smith at a rent of £20,000 per annum will not be as valuable as the equivalent property let to W H Smith upon the same terms.

For a sale by auction, the seller must set down the terms of the tenancy-to-be in advance of the sale. In the case of the first of the two investments, the rent was set at £28,000 per annum. Remembering that the sale price was £368,000, we can thus calculate that each £1 of annual rent was worth £13.14 in capital terms. It must be tempting to surmise that setting a higher rent would have resulted in an even larger capital sum. However, this would be a mistake for two reasons: firstly, because the rent may prove to be more than the business of the (new) tenant can sustain; secondly, because the auction market is sophisticated enough to be able to devalue overrented property. Thus, setting an affordable, market level of rent is actually an advantage over attempting to “gild the lily”.

Length of term is also an important factor. From a buyer’s point of view, it is much easier to secure third party funding (in other words, borrow from the bank) upon a longer, more certain income stream. In the auction sale and leaseback market, a guaranteed income of at least fifteen years is usually necessary.

Finally, strength of covenant is important. The analogy of the two Smiths should make clear the difference between the value of an income stream secured against an individual and one secured against a nationwide multiple retailer. In marketing the two lots detailed above, we provided extracts from their most recent audited accounts, which demonstrated pre-tax profits of £117,000 and a net worth of £135,000: with respect to the estate agent, hardly the stuff of a FTSE 100 company but at least sufficient to provide the market with some comfort that a rent of £28,000 per annum ought to be affordable.

What we haven’t asked here is why this agent – or anyone else offering a sale and leaseback – would want to do so. The answer is usually self-evident: sale and leasebacks raise capital. True, they also incur a liability going forwards in the form of rent, but for a settled business they may represent an opportunity to expand more rapidly than would be possible through purely organic growth.

Auctions usually represent the best means of marketing High Street sale and leasebacks, because of the lot size and the breadth of market coverage that auctions use. They also have all the usual benefits of open market competitive bidding, plus the certainty that comes from the exchange of contracts being made upon the fall of the hammer.

I’ll probably be proved wrong here by an assiduous auction-follower, but the two examples listed above from our September auction are the only two that I can think of that derive from a regional estate agency chain. In light of these successes, I expect more to follow.

By Felix Rigg BMus who is the Principal Auctioneer with Harman Healy Commercial, a member of Erinaceous Group plc