The New York Times recently reported that takeovers by private equity firms in the first half of the year rose over the same time last year to about $114 billion.
Consistent with this data, experts have estimated that financial sponsors are sitting on more than $400 billion in capital right now and are looking for ways to deploy it. Prior to the recession that began in the second half of 2008, M&A transactions were getting done with as little as 20% equity and 80% debt financing. For middle-market deals (below $1 billion), which are reported to make up the bulk of current M&A activity, required equity levels are currently in excess of 50%.
The Dodd-Frank Act and Basel III have required banks to maintain higher capital ratios. Consequently, sources of debt financing for middle-market firms in the process of growing and building their businesses are often more limited, and stricter leverage requirements apply. As a result of these factors, sale-leaseback deals are proving to be a critical piece of the acquisition financing package for private equity firms acquiring companies with significant operating assets, including offices, factories, warehouses, distribution and other types of facilities essential to their businesses.
In a typical sale-leaseback deal, the corporate property owner sells real estate at fair market value to an investor, who then leases the property back to the previous owner under a long-term, triple-net lease. For example, in the recent private equity acquisition of a portfolio company with significant operating facilities, $100 million of the total $145 million purchase price was financed via a long-term sale-leaseback of properties critical to the company's business. The balance of the purchase was funded through a 50-50 combination of equity contributions by the private equity firm and bank financing.
In addition to pricing, critical issues for private equity firms include certainty of the purchaser's ability to fund the deal at closing, the investment objective of the purchaser, and its reputation and capabilities as a "landlord." Sale-leaseback investors with long-term-hold and income-oriented investment objectives, a history of holding their assets for the long term, and a reputation for working with and being supportive of tenants tend to align with the larger corporate growth and value-add strategies of portfolio companies and their owners.
For the sale-leaseback investor, evaluating the sustainability of earnings and cash flow, and thus the company's ability to pay rent into the future, is a critical and an increasingly complex part of the due diligence process. In addition to the history of the company's business and the reputation of the private equity firm, sale-leaseback investors must also look to their own analysis of a company's position within its industry, quality of management, business strategy and a capital structure that will support the growth and operation of the business over the long term.
Sale-leaseback financing can also serve as an attractive capital source for portfolio companies already owned by private equity firms. Many middle-market businesses today are seeking financing for working capital purposes -- hiring people, building inventories and, in some cases, new facilities. Build-to-suit financings, whereby a company works with a developer to design and build a facility to meet its specific needs, can often be 100% financed through a vehicle that provides funding during the construction period and then rolls into a long-term net lease upon completion.
An example of this type of financing is the build-to-suit financing of a distribution center in Bowling Green, Ky., for Sun Products Corp., a portfolio company of Vestar Capital Partners. The $41 million financing funded the construction of a 1.4 million-square-foot facility to be leased to Sun Products under a long-term triple-net lease.
The new facility will enable the company to consolidate operations of nine other facilities in the Bowling Green area. Located adjacent to one of Sun Products' four manufacturing plants, the distribution center will be one of two distribution facilities serving the entire East Coast.
In an environment where private equity firms are looking to deploy funds and middle-market companies and others are looking to grow their businesses, sale-leaseback financing can play a critical role in making deals happen and in ensuring the availability of capital for their future success.
Jason Fox is managing director and Georges Asmar is vice president of W.P. Carey & Co. LLC. Affiliates of the company provided funding for the transactions described in the article.