Property in play

Property assets owned by companies should be regarded just like capital and should be worked just as hard. This point has long been gospel amongst many shareholders, bankers and CEOs in the US but, outside dyed-in-the-wool real estate investment circles, it is still something of a radical concept in Europe. To illustrate, around 70 per cent of European companies continue to own the space they occupy. In the US, the equivalent number is closer to 30 per cent. This disparity has its roots in deeply ingrained differences in the two markets' respective business cultures: one has developed a pragmatic approach to property usage and ownership, the other has yet to acquire such a mindset. Yet this may now be changing. The reason is the steady rise in popularity amongst Europe's corporate management and their financiers of asset backed finance that utilises property sale and leaseback techniques that have been tried and tested in the US.

?Managers of businesses are increasingly asking, ?why have we got our capital tied up in property, why does it sit on the balance sheet where it earns pittance??? says James Longden, director in charge of European operations at W.P. Carey, the US-headquartered property-financing house. ?This is also beginning to focus the minds of private equity investors. Financial sponsors are key partners for us, [even though] in Europe we have yet to see the level of deals involving real estate refinancings that is common in the US.?

In its home market, Carey has seen a rapid growth in assets under management, as US retail investors have flocked to Real Estate Investment Trusts (REITs) in pursuit of mezzanine-style, long-term returns. The company now has $5bn under management via its REIT programme. In 2002, Carey invested over $1bn in US corporate property, more than twice as much as in 2001. Now a similar push is scheduled for Europe.

Longden says that unlike real estate opportunity funds or European institutions investing in property assets, his focus is on income rather than capital growth. ?The property fundamentals must stack up, but they're not the sole reason for doing the deal.? At least as important is the sustainability of the companies whose real estate Carey acquires, i.e. their ability to pay rent over five, ten or 20 years. That says Longden is why Carey's due diligence is similar to that carried out by private equity investors, and one reason why financial sponsors make attractive partners for the firm to co-invest with.

The opportunity currently presenting itself to sales and leaseback specialists working with European equity sponsors is mainly driven by the fact that refinancing is generally becoming more appealing in the current market environment. With the IPO market more or less shut and banks' enthusiasm for lending on the wane, financial investors are increasingly looking to incorporate corporate real estate in their approach to funding deals. ?Sale and leaseback is an increasingly important financial engineering tool in our kit box that we like to turn to whenever appropriate?, comments a partner at a UK-based mid-market firm.

So far European sponsors have turned to asset-based refinancing some time after investing in a business in order to free up capital when necessary. However, a transaction such as Cinven's May 2002 acquisition of National Car Parks (NCP) suggests that financial buyers are beginning to think differently. NCP had a valuable portfolio of properties that enabled Royal Bank of Scotland to devise a sale and leaseback structure that was a key component of the buyer's original funding strategy. In this case, Cinven and RBS effectively turned NCP's operations and its property assets into two separate companies. These types of transactions are demonstrating to the market that bringing relevant know-how into a deal early on can yield significant benefits.

Says Longden: ?Most of our deals have been like a second line of funding, often two to three years after private equity financing had gone into the business. After several deals in Europe, we're building our relationships with private equity investors while they become more familiar with what we can do for them and their portfolios, complementing their own investment strategies.?

To date Carey has invested some $500m in European transactions, but is hoping to put between $1bn to $1.5bn to work in the region over the coming 18 months. Part of the challenge will be to convince European managers that being a tenant rather than your own landlord doesn't have to be a bad thing. If that can be done, and given how much real estate tends to be tied up in a large leveraged buyout, a billion and a half dollars may not be that tall an order.