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Is the Net Lease Industrial Market Still "Red Hot"?
The single-tenant net lease industrial market has been on fire in recent years. Buoyed by e-commerce growth, industrial properties were seeing record low cap rates and record high competition from investors following the COVID-19 pandemic. However, the sector has not been immune to recent macro-economic volatility. Search -In fact, quarterly transaction volume fell more than 46 percent in the first quarter of 2023, making it the slowest quarter reported by the net lease industrial sector since mid-2017. Does this mean that the industrial market is losing its steam? While some investors are waiting on the sidelines, trends including onshoring, supply/demand dynamics and rising interest in sale-leasebacks will help bolster the industrial market in the long term. Here’s why: Impact of onshoring Supply chain issues during the pandemic have been a major catalyst for onshoring in the industrial market. Having manufacturing facilities overseas meant accessibility was limited (or in some cases, completely restricted), which had a major impact on companies’ ability to get their product to consumers. As a result, more companies have focused on bringing their facilities back to the U.S., which has only been supported by lower labor-related costs, better automation technology and an accessible highway and interstate system. Technology companies have largely been leading the onshoring charge, with companies like Intel, Micron and Texas Instruments committing to building large manufacturing plants in the U.S. This has led to a steady rise in demand for warehouse and industrial spaces from U.S. companies, with notable growth seen in the Southeast. Supply/demand dynamics After several years of growth post-COVID, warehouse construction is on the decline due to higher interest rates, a slower economy and Amazon’s reduced spend on new facilities for 2023. 6,700 warehouses are expected to be built in 2023, a 35% reduction compared to the 10,000 built in 2022. Despite this, e-commerce growth is expected to keep demand for warehouse space strong, with rents anticipated to increase over the next year. The good news for investors is that cap rates are also on the rise – Search -up 35 basis points from record lows in 2022. As the buyer-seller price gap continues to close, more investors will likely jump back into the market, strengthening transaction volume in 2024. Uptick in sale-leaseback interest The volatility in the capital markets environment has certainly been challenging for companies, with cost of capital rising considerably given increasing interest rates. Alternative forms of financing such as sale-leasebacks have come to the forefront as companies look for ways to unlock capital. Sale-leasebacks offer a “naturally accretive” funding source, particularly for companies that own fungible, mission-critical real estate and are willing to sign a long-term lease. Industrial facilities have inherent criticality which makes them uniquely attractive to investors, making owners of these types of facilities great candidates for sale-leasebacks. While inflation is starting to cool, experts predict that the Fed won’t start cutting interest rates until 2024, which will encourage more industrial companies to pursue a sale-leaseback. With more opportunities likely coming to market and investors poised to execute (particularly all-equity buyers), we believe industrial will maintain its position as the “darling” of net lease for the foreseeable future.
Three Ways Real Estate Investors Can Recession-Proof Their Portfolios
Economic experts are continuing to signal that a recession could be on the horizon. A number of factors are contributing to this sentiment, but recent bank failures, tightening credit, interest rate increases and sustained high inflation are among the biggest. To help prepare in case of a downturn, below are three things real estate investors can do to “recession-proof” their portfolios and position their business for long-term success. Prioritize diversification When it comes to portfolio resiliency, diversification is key. Investing in a range of geographies, asset types and industries reduces potential risks tied to individual market volatility. If one particular asset class is more heavily impacted by a recession than others, having a diverse portfolio comprising several asset classes reduces the overall impact. Portfolio diversification also allows investors to allocate capital to where they are seeing the best risk-adjusted returns. This means investors can be nimble and take advantage of unique opportunities should they arise. Focus on mission-critical real estate To be successful in commercial real estate investing, it’s important to focus on properties with strong fundamentals, such as location, size and quality. However, when positioning a portfolio to weather all economic cycles, arguably the most important aspect of a property to focus on is “mission criticality,” or how important the property is to the tenant’s operations. When a property is mission critical, a tenant is more likely to remain in the facility – both in good times and in bad – for the long term. The worst thing that could happen during an economic downturn is to have a portfolio of vacant assets – and therefore limited rent payments – so by focusing on mission criticality, investors can better ensure durable, long-term cash flows. Analyze tenant credit and business Disciplined credit underwriting is critical to long-term portfolio success. Large tenants with a strong underlying credit and revenue history will be better equipped to weather downturns through access to liquidity, or in a worse-case scenario, have the ability to restructure and continue operating in their mission-critical properties. In addition to a tenant’s financials, it’s also important to examine the long-term outlook of the tenant’s business and industry. For instance, a tenant that produces electric car engines may have a better long-term outlook – and therefore be better suited to a long-term lease – than one that produces gas-powered engines given the trend toward electric vehicles. Final thoughts It’s never too late for real estate investors to look at their investment strategies and take steps to enhance their portfolio resiliency. Focusing on long-term stability – through diversification, mission-critical real estate and creditworthy tenants – versus short-term gains will help investors to build portfolios that will carry them through all market cycles.
Why Consider a Sale-leaseback?
In today’s economic environment cash is king, and businesses both large and small are looking for ways to boost their cash flows. That’s why an increasing number of companies are monetizing their real estate to unlock otherwise illiquid capital through sale-leasebacks. Sale-leasebacks give companies the liquidity needed to address a number of strategic and financial initiatives and are growing in popularity. Here are three of the biggest factors motivating companies to pursue a sale-leaseback now. Cheaper alternative to debt When it comes to raising capital, companies typically have a menu of options to choose from including high-yield bonds, bank debt, equity raising or sale-leasebacks. However, some of these methods have been more negatively affected by higher interest rates than others.For instance, bonds and bank debt have both increased by more than 400 basis points since early 2022. On the other hand, cap rates on sale-leasebacks have risen significantly less – about half as much – making sale-leasebacks a more attractive alternative on a relative cost of capital basis. From a purely financial standpoint, this is driving more companies, particularly those with high-quality, mission-critical real estate assets, to leverage sale-leasebacks as one of their primary forms of capital raising. Capital to reduce leverage Given recent economic volatility, more companies are seeking to strengthen their overall credit metrics and capitalization to best position themselves for the future. Sale-leasebacks are a great solution for companies looking to reduce leverage, as the proceeds can be used to pay down shorter-term debt or maturing debt that has become significantly more expensive to refinance. The reduction in leverage helps improve both a business’ debt / EBITDA ratio in addition to debt / capitalization, which can improve a company’s overall credit and better position them for the long term. M&A financing Company valuations remain significantly lower than early 2022. While this has caused an overall reduction in volume in the M&A market, some businesses are taking advantage of the fact that their acquisition targets may have become cheaper. For companies looking to opportunistically expand through M&A, sale-leasebacks are an excellent tool to add to the capital stack. By pursuing a sale-leaseback concurrently with a new acquisition, the acquirer can reduce their equity check and boosts returns – effectively ‘buying down’ the acquisition multiple. Private equity firms, in particular, are increasingly using this technique for buyouts. Read about W. P. Carey’s recent transaction with SK Capital and Apotex to learn more. Closing thoughts While sale-leasebacks are a great capital tool in high-interest-rate environments, they can be just as useful in less turbulent climates. Freeing up capital from owned real estate – in any stage of the market – is an excellent way to invest in the core competencies of a business and fund internal and external growth objectives. Interested in exploring a sale-leaseback? Contact W. P. Carey today!
Where Net Lease is Heading
With financing options restricted by interest rate uncertainty, corporate real estate sellers have been turning to sale-leasebacks. It’s easy to see why: these deals offer liquidity and immediacy. For the net lease sector at large, Tyler Swann, managing director, investments at W. P. Carey, is seeing US deal flow coming almost exclusively from new sale-leasebacks versus acquisitions of existing leases, a change largely driven by the changing capital markets landscape. CRE Psychology Playing Catch-up As interest rates have risen and asset values have fallen, the pricing expectations of sellers have not followed suit. That’s led the market to favor new sale-leasebacks as opposed to investment properties that are acquired from third-party landlords, Swann says. "There's a disconnect between what buyers can realistically pay given current capital markets and what a seller wants,” he says. “It takes time for psychological expectations of sellers to reset and I think we haven't seen that play out just yet, which is why those existing lease deals haven't really been moving or coming to market at all.” New sale-leaseback sellers are more realistic, comparing and choosing the costs of such a deal versus the current cost of capital, especially the added expense of raising debt in the current high interest rate environment. The benefits of the here and now – unlocking their CRE equity means it's "go time" for deals, unlike the often disparate expectations of a third-party landlord seller. Open Opportunity, With Caveats While there are fewer overall opportunities in the net-lease market compared to the last couple of years, there are fewer market challengers due to the more restricted financing options. “Plenty of investors who were very competitive just a couple of years ago, for example, were reliant on CMBS debt and are now no longer nearly as competitive as they used to be,” Swann says. “And that's given us a leg up.” Office demand continues to suffer from uncertainty, mainly from lagging return-to-office efforts and hard-to-figure valuations given the large amounts of vacant and shadow space. On the plus side, Swann views the industrial sector as the most favored by net lease investors, as strong demand post-COVID for logistics facilities persists, with companies building out their supply chains amid a more general move to on-shoring production. Earlier this year, W. P. Carey completed an approximately $468 million, 20-year lease sale-leaseback with Apotex for a portfolio of pharmaceutical manufacturing assets in the greater Toronto area. Swann points out that the combination of sector (industrial), type (new vs. existing lease) and trend (taking advantage of better cost of capital through a sale-leaseback) all led to the deal getting done. “In a lot of ways I think that Apotex deal is a good example of where the market is going,” says Swann.
Here Comes the Sun!
Real estate, one of the largest contributors to carbon emissions, accounts for approximately 37% of the world's greenhouse gas emissions. This makes it a critical sector in the global effort to combat climate change. Fortunately, there are many solutions available to help reduce the carbon footprint of real estate, and one of the most impactful is solar power. This article discusses key benefits of installing solar panels for CRE occupiers. Save on the Cost of Power Solar panels allow buildings to generate their own electricity, reducing the amount of power tenants need to purchase from the grid. This is particularly beneficial for commercial real estate, where energy costs can be a significant expense for tenants. By installing solar panels, tenants can reduce energy bills, freeing up resources to reinvest in their businesses or operations. In addition, they can potentially earn revenue by selling excess power back to the grid through net metering programs. Hedge Against Utility Rate Increases The cost of energy varies and can rise unexpectedly due to factors like fuel costs or infrastructure maintenance. As a result, occupiers who rely solely on the traditional grid electricity for their power are subject to rate increases that can impact their operating costs. Based on data from the U.S. Energy Information Administration, electricity costs in the U.S. have increased by 2.28% on an annual basis from 2005-2020 and 7.08% since 2020. Through solar energy, companies can protect themselves against unplanned rate increases and stabilize their energy expenses. Solar panels can also reduce over-reliance on the grid during peak periods when the electricity demand is high compared to the supply. Moreover, solar panel systems have a long lifespan and require minimal maintenance. It means tenants can continue to benefit from the fixed cost of solar energy for many years, even as traditional grid electricity rates continue to rise. Reduce Carbon Emissions and Support Corporate Sustainability Goals Traditional energy sources, such as fossil fuels, produce greenhouse gas emissions that contribute to climate change. On the other hand, solar panels generate electricity using the sun, a renewable energy source that does not produce harmful emissions. Occupiers who install solar panels can minimize their carbon footprint and contribute to the wider goal of reducing greenhouse gas emissions. It can also help them achieve their corporate sustainability goals and align with the expectations of their stakeholders, including investors, customers and employees. Receive Renewable Energy Certificates (State Dependent) Tenants who install solar panels on their building can also receive Renewable Energy Certificates, or RECs, to offset carbon emissions. One REC is issued for every MWh of electricity generated and delivered to the grid by a renewable energy resource. The use of renewable energy, verified with RECs, ensures a company’s electricity is provided from renewable sources that produce low- or zero-emissions, thereby reducing the tenant’s market-based scope 2 emissions. Start Enjoying the Benefits of Solar with W. P. Carey Installing solar is one of the best things companies can do to shrink the carbon emissions of their buildings. If they lease their real estate, leveraging their landlord relationship is a great way to explore options for solar installation. W. P. Carey, a leading real estate investor with over 1,400 properties, recently launched its CareySolar program, a solution providing eligible tenants the opportunity to take advantage of rooftop and carport solar installations on their leased properties with no upfront investment. By embracing opportunities like this, companies can save money, reduce their carbon emissions and help the environment. Contact W. P. Carey today to learn more!
Why Net Lease Continues to Draw Investors
The net lease retail sector continues to outperform despite changing interest rates, with a growing number of retailers expanding their footprints or developing new properties against a “compelling” cap rate environment. That’s according to Michael Fitzgerald, executive director, head of US Retail, W. P. Carey, who told GlobeSt at ICSC Las Vegas that many retailers are “aggressively expanding” in their markets. “We’ve seen a lot of activity in sale-leaseback and we are bullish on net lease retail,” Fitzgerald says. “The retail sector is enormous – and we’re chasing deals.” Fitzgerald also discusses: The state of retail fundamentals How investors are responding to changing interest rates and economic uncertainty What makes W. P. Carey stand out from its competitors in terms of investment opportunities Watch now An interview with Michael Fitzgerald, W. P. Carey, and Holly Amaya, GlobeSt.com.
Navigating a Rapidly Changing Retail Industry
Over 20,000 real estate investors, developers, property managers, retailers and brokers convened in Las Vegas last month for the annual ICSC convention. In the midst of a volatile market, attendees sought answers on how to navigate current challenges impacting the retail industry. Below were three of the biggest themes to emerge. Retail resiliency amid market headwinds Just a few years ago, the outlook for the retail industry was grim. Consumers weren’t shopping due to the pandemic, brick-and-mortar stores were closing and many large retailers were filing for bankruptcy. However, the market surprisingly bounced back post-covid as consumers returned to stores with a desire to spend. As the real estate industry as a whole now contends with new challenges including higher interest rates and economic uncertainty, the silver lining is that retail has been somewhat less impacted than other asset classes. Office continues to face return-to-work challenges and industrial is contending with supply chain bottlenecks and overall supply shortages. While retail has not been entirely insulated, the fundamentals have remained quite sound – leasing remains strong, occupancy is high and companies are continuing to announce new store openings. The consensus at ICSC was that there are certainly challenges ahead, but that the retail industry is well positioned to weather the storm and come out in a position of strength. Trend toward mixed-use retail One of the biggest challenges in today’s retail environment is adapting to the growing and changing needs of the everyday consumer. As a result, landlords, retail owners and developers are increasingly exploring mixed-use developments – which blend multiple uses such as retail, residential and entertainment. For instance, a landlord may decide to redevelop an existing retail center by incorporating entertainment facilities, residential apartments and hotel amenities that attract consumers while also helping drive sales and boost profits. Landlords are also embracing a more experiential approach to retail centers by incorporating movie theaters, fitness centers, spas and other lifestyle attractions. Particularly now when ground-up retail development is not the most attractive given the current market, converting existing retail centers into mixed-use sites is a unique way for landlords to maximize value and grab consumer attention. Sale-leasebacks as a solution for rising development costs Rising interest rates continue to impact retail development. Developers’ capital costs have increased drastically, and as a result they are demanding higher asking rents from retailers. This is forcing more retailers to turn toward in-house development, which means the development costs are held on the balance sheet of the company. To offset these costs, retailers are exploring sale-leasebacks – where a company sells its real estate to an investor for cash and simultaneously enters into a long-term lease. This enables the retailer to receive a significant cash infusion while maintaining full operational control of the property. Developers can also take advantage of the sale-leaseback model. If they’re developing a building in which a tenant has already been secured, developers can work with an investor on a forward commitment in which the investor funds construction costs and acquires the building upon completion, or the investor purchases the building once complete. This enables the developer to recoup costs while still collecting a development fee. With an interest rate decrease not likely for 2023, sale-leasebacks are expected to continue growing in popularity for retailers looking to expand their footprints and developers, providing opportunity for investors that specialize in these types of transactions (like W. P. Carey!).
6 Reasons Why Alternative Financing is a Hot Topic for CFOs
In today’s fast-changing environment, CFOs are increasingly focused on transformation and strategically positioning their organization for future success. However, serious financial stressors are making that job difficult, as cash is more difficult to secure. To ensure their business is set up to succeed, CFOs are investigating alternative sources of capital. One such alternative is a sale-leaseback, where a business sells its real estate to an investor for cash and simultaneously enters into a long-term lease. Many predict alternative financing methods, such as sale-leasebacks, will grow in popularity over the next year. Here are six reasons why: Climbing Interest Rates The Federal Reserve hiked interest rates throughout 2022 to tame inflation. This trend is likely to continue in 2023, with the Fed raising interest rates for the 10th time in a row in May in its ongoing efforts to curb inflation. High interest rates make traditional loans expensive and hard for some companies to secure, particularly those that are sub-investment grade. It also makes refinancing more challenging, putting CFOs with debt coming due in a difficult position. The logical option is to find alternative avenues to secure capital to pay near-term debt and create growth opportunities for the future. Inflation Remains High Although inflation has begun to cool, the annual rate as of April 2023 is 4.9%, much higher than the Fed’s target of 2%. As a result, the price of commodities, raw materials and labor remains high, forcing most businesses to eat into their savings to stay afloat. For CFOs looking to develop capital-raising strategies that will provide cash without putting an intense strain on their business, alternative financing methods such as a sale-leaseback are a great option. Looming Possibility of Recession The World Bank has been slashing earlier economic growth figures it had projected, indicating that we may be headed into a recession in the coming months. Global economic growth had been initially projected at 3% but was later reduced to 2%. This reflects the third weakest pace of growth in nearly thirty years, exceeded only by the global recessions caused by the pandemic and the global financial crisis. A recession is extremely difficult on businesses, and often results in significant declines in sales and profits, layoffs, slashed capital spending and restricted financing access. If that's where the economy is headed, the best way for CFOs to prepare is to start looking for alternative financing to increase cash flows and bolster their balance sheets to weather the storm. The Talent War Continues The great resignation took the war for talent to a higher level as labor shortage became rampant, and the skills gap widened even further. Companies are being forced to reskill or upskill to meet current demands. Training magazine shows this data that reveals why reskilling is essential: 57% of US workers want to update their skills, and 48% would consider switching jobs. 71% of workers say job training and development increase their job satisfaction. 61% say upskilling opportunities are an essential reason to stay at their job. 94% of workers would stay at their company if their company invested in their careers. Reskilling takes financing. With the average cost to reskill an employee standing at $24,800, coming up with an actionable capital-raising strategy is critical. Increased Customer Expectations The great resignation took the war for talent to a higher level as labor shortage became rampant, and the skills gap widened even further. Companies are being forced to reskill or upskill to meet current demands. Fast solutions to customer complaints Access to preferred service channels Opportunities to answer questions themselves through help centers Hyper-personalized experiences Data protection and privacy Growing or staying in business is impossible if you can't meet these needs. Recent reports show companies have already begun investing in stellar customer experiences, with those investing in omnichannel experiences jumping from 20% to more than 80%. Also, 84% of companies are focusing on improving mobile customer experience. Because improving customer experience means investing in tech, spending will increase, requiring CFOs to come up with intelligent ways to shore up extra capital. Accelerated Digital Transformation Beyond the rampant use of AI, other disruptive technologies such as blockchain, the cloud and IoT are becoming more common and interdependent in improving business functions. These technologies are not static either but are continually evolving, creating the need for businesses to rethink their structure and ensuring employees across all levels can keep up with the technology. Despite the potential recession and tough economic times, developing solid digital strategies and reviewing existing tools and processes for efficiency gaps will help create a unified approach to digital transformation. As with other processes, transformation requires cash, so CFOs will likely turn toward alternative financing strategies to unlock the capital needed. Final Word 2023 is full of headwinds for CFOs, which will require businesses to explore unique capital strategies to ensure they have the cash needed to succeed. At W. P. Carey, we specialize in sale-leasebacks and work with CFOs to help them monetize their real estate and redeploy that capital back into their businesses. Particularly in today’s economic environment, CFOs will likely find that the rate at which they can monetize their real estate through a sale-leasebacks is more attractive than the current long-term borrowing rate. With significant dry powder, 50 years of experience and the ability to provide certainty of close, W. P. Carey is poised to deliver much-needed capital for companies interested in exploring sale-leasebacks. Contact us today to find out if your company and real estate are a good fit!
How Private Equity Can Leverage Sale-leasebacks
Sale-leasebacks are often used by private equity firms to raise capital to support portfolio company growth. Through a sale-leaseback, private equity firms can unlock otherwise illiquid capital tied up in portfolio company real estate and reinvest the proceeds into its core business. Here’s how private equity firms can leverage sale-leasebacks to generate long-term value: Maximize portfolio company value by reinvesting sale-leaseback capital into its operations Following the completion of a sale-leaseback, private equity firms can immediately invest the proceeds into its portfolio company’s business operations to support long-term growth. These include investments in new facilities, technology, equipment, R&D and human capital. The benefit of pursuing a sale-leaseback instead of other debt alternatives is that PE firms can realize 100% fair market value for the portfolio company real estate. For example, W. P. Carey worked with a middle-market private equity firm on the $19 million sale-leaseback of two industrial facilities leased to a global distributor of plastics. The private equity firm used the transaction proceeds to secure long-term capital to expand portfolio company operations and fund future growth initiatives. Pay down existing debt and provide portfolio companies with balance sheet flexibility Private equity firms can use sale-leasebacks as a method to recapitalize and strengthen the credit metrics of their portfolio companies. Particularly for smaller, non-credit-rated companies that cannot access the capital markets, a sale-leaseback is a great tool to provide balance sheet flexibility and enable portfolio companies to pay down maturing debt and other liabilities. By improving the balance sheet, private equity firms can position a portfolio company for a credit upgrade or even an IPO, maximizing the long-term value of the company. In 2020, W. P. Carey provided a private equity firm $40 million in sale-leaseback financing for a manufacturing facility leased to a global leader in barbecue grills and accessories. Proceeds were used to pay down debt and improve the balance sheet, helping position the company for a positive credit improvement. Shortly after the sale-leaseback, the company completed an IPO raising over $250 million. Compete more effectively for new acquisitions and M&A Sale-leasebacks can be used by private equity firms to help finance add-on acquisitions – where a PE firm acquires a new company and mergers it with an existing portfolio company to generate growth. By carving out real estate from a business during or post-acquisition, private equity firms can unlock substantially higher value for the real estate due to the spread between the lower cash flow multiple paid to acquire the business and the much higher cash flow multiple received from the sale of the real estate itself. As a result, sale-leasebacks are a capital-efficient way to maximize portfolio company growth while also serving as a positive arbitrage opportunity for private equity firms. W. P. Carey worked with a private equity firm on the $29 million sale-leaseback of four industrial facilities leased to a global manufacturer and distributor of vehicle-mounted aerial lifts. Proceeds from the transaction were used to partially fund the manufacturer’s acquisition of a German company in the same industry, enabling them to expand their market share in Europe. Conclusion Sale-leasebacks are a highly attractive capital allocation tool with many strategic and financial benefits for sponsored companies. Real estate financing can be an extremely effective way to fund growth and add value to portfolio companies, particularly in today's high-interest rate environment. In order to maximize proceeds, PE firms considering a portfolio company sale-leaseback should work with an all-equity buyer with experience working with all types of credits. W. P. Carey has partnered with private equity firms and their advisors on these types of transactions since 1973, and has provided over $5.7 billion in capital to PE firms and their portfolio companies. If you’re interested in pursuing a portfolio company sale-leaseback, please contact us at globalinvestments@wpcarey.com.