In recent years, the region has seen a number of sale-and-leaseback (SLB) transactions undertaken by entities such as school operator GEMS & Repton, the grocer Azzizah Panda and Lulu, dairy company Safi Danone and retailer Jarir.
Although data on all concluded transactions are not transparently known in the market, JLL estimates the size of the market to be around circa $200 million per annum and expected to grow in the years to come, as the success of these transactions and ones underway become well-recognised.
While BTS (build-to-sell) is less prevalent, the GEMS school deal in Doha and the Jebel Ali Primary School deal in Dubai are publicly known, where the school building was custom-built by a financier on the back of a long-term lease.
I am currently advising a number of entities on such transactions, which confirms that the market will see more of these across asset classes, including education, health care, offices, retail and workforce accommodation.
However, I often find these transactions are not structured appropriately, creating sustainability risk for the tenant or the purchaser. It is in this area that my colleagues and I are doing quite a bit of work in establishing deal structures that are fair to both parties and are market-backed.
In particular, we focus on the following aspects that impact a typical SLB or BTS transaction:
• Starting rent — Ensure the asset is rented ‘at market’, so that the purchaser does not seek a rent that becomes unsustainable over time and increases the risk of tenant default. We do this by assessing the market environment and incorporating any elements of the property that would make it unique, to justify a higher or lower rent than the market. As a rule of thumb, the rent shouldn’t exceed over 15 per cent of the gross revenue and should be no more than 50 per cent of the underlying Ebitda.
• Rent escalations — Investors always seek escalations in rent to match the inflation in the market. Establishing the appropriate increase or matching the increases to revenue growth is critical to avoid bottom-line shocks over time when the rent inflates.
• Duration of lease and break options — Establishing a suitable duration of leaseback is critical to ensure that the value of the asset is maximised, yet does not pose more risk than necessary to the seller/tenant. Generally, a longer lease achieves a higher value, however, the appropriate balance of business risk and upfront value creation is important to be assessed.
• Buyback call/put options — Some tenants seek the possibility of reacquiring the asset when their funding lines open up and establishing the structure of the buy-back terms is important to manage risk on either sides. A call option provides the holder an option to acquire, while a put option creates an obligation. Understanding the risk and reward on either is important for both parties.
• Cap rate — On a SLB this is dependent on many factors including the historical operating performance of the business, the strength of the parent company guarantee and the lease back terms. In an environment where debt is becoming expensive and risk-free rate is rising, I see cap rates of 7.5-8.5 per cent for long term leases to be a fair reflection of the real estate and asset class risk that investors take.
For a BTS transaction, a development margin of 20 per cent on development cost is considered necessary to justify the risk of development. This results in a cap rate of 9-10 per cent on Estimated Market Rental (ERV) for the property.
I often get asked the cost benefit of an SLB/BTS to the seller vis-a-vis debt funding. In my opinion, unless there is identified use of the released equity, either to grow the business or to retire debt, it makes less sense to undertake a SLB or BTS funding. While debt is always cheaper than equity, the gap between cost of debt and acquisition cap rates have reduced over the past 12 months, which now makes undertaking a SLB or seeking a developer for a BTS a more financially viable solution for the corporates.
Notably, another reason for a growth in such transactions is the increase in demand for it. This predominantly comes from asset managers, institutions and sovereign entities, who are seeking opportunities to invest in real estate, but do not have any interest in its management.
A SLB or BTS transaction, where the management of the asset remains the responsibility of the tenant and the lease is triple net (including maintenance, insurance and property related taxes) is ideally suited for such investors.
Overall, the lower liquidity in the market, the benefits of reducing exposure to real estate and increase in institutional investors, is going to create more transactions in the SLB/BTS space in the short to medium term in the region.
I am hopeful that most will be structured appropriately to ensure they are sustainable over the long term, and create this alternative funding option for corporates.
The writer is Head of Real Estate Transaction Services, MENA at JLL.
