Sale-leasebacks: Europe’s Answer to the Housing Bust

In the dawn of what may become the largest real estate recession of all time, Americans are not the only ones to feel the bursting effects of the housing bubble. In fact, several European financial firms that were heavily invested in the U.S. housing market have been hit as hard, if not harder, than similar domestic companies. But while the situation at home continues to deteriorate, and it is deteriorating, the Europeans have identified a way to reallocate their assets and realize a positive return on real estate investments through the sale-leaseback process.

The sale-leaseback technique basically means that a company who owns the real estate it occupies will sell it to a purchaser who, in turn, immediately leases the property back to the company. This method is mutually beneficial for both parties: it allows the seller to generate a substantial amount of cash that can be used elsewhere, while at the same time, it gives the purchaser the stability of regular lease payments.

Historically, European and American philosophies have contradicted one another on this matter. Generally speaking, European companies felt compelled to own the land their company occupied, something akin to the “family silver.” In the United States, however, just 20% of corporations own the land they occupy, three times less than the amount in Europe. With the explosion of the housing bubble, European banks have seen their cash-pools dry up as they are left holding unwanted mortgage-backed securities. In turn, their ability to lend has been severely restricted and thus the cost of obtaining capital for these European companies has significantly increased, making it more apropos to sell one’s real estate to fund other operations rather than borrow money.

The practice of sale-leaseback is also working for companies who appreciate the financial model and see it as a way to redeploy assets and balance out their portfolios. For instance, Barclay’s-one of the world’s largest banks-has done sale-leaseback deals worth nearly $800 million in the last year and a half. These large transactions have attracted both foreign providers of capital as well as smaller companies in search of a buyer. The European market for sale-leasebacks is growing so quickly that Boston-based STAG Capital Partners recently opened a new office in London purely for their European sub-grade capital asset investments.

Like any investment, the acquisition and re-deployment of real estate yields a return proportionate to the risk of the security, which in this case, is the lessee. The smaller-to-mid-size firms, or ones with sub-investment grade credit worthiness, can generate returns much greater than the cost of capital. On the other hand, however, investments that are simply “financial re-engineering” of a company’s financial structure generate normal returns; around 5% in the U.K. and somewhere closer to 6% most elsewhere in Europe.

In any case, the growth in the sale-leaseback market has at least given real estate investors a reason to go to work in the morning; investor’s phobia of American real estate has caused stagnation in the market. Mortgage securities, especially sub-AAA rated ones, lie unsold and depress the margin of liquidity for banks, brokerages, and hedge funds alike. For those firms that have already collapsed, sale-leaseback’s might not be the solution, but for the industry, this may be the light at the end of the tunnel. Like STAG Capital Partners, American investors should consider some sort of European asset-backed security or debt-obligation, which, through these deals, could potentially revitalize their portfolios and eventually, the investor confidence and the market.