Accounting/Financial ReportingLeasing
As tough times persist, more companies consider monetizing their real estate assets
By Ed Zwirn
High-end computing supplier Silicon Graphics Inc. faces the same set of problems these days roiling most erstwhile high-tech darlings: mounting losses, a pummeled stock price and an increasingly unappetizing balance sheet. Not surprisingly, the Mountain View, Calif.-based company—making a mark recently with its animation technology contributions to box office hits Monsters Inc. and The Lord of the Rings—spends almost as much time these days developing new ways to cut costs and improve its return on equity as it does making computer-generated effects.Of course, the first cuts involved the standard spinoffs and selloffs. But SGI also found unexpected, underperforming assets just sitting around taking up square footage, so to speak: the seven Silicon Valley office buildings housing the company’s operational headquarters. “Apart from providing the physical space for the company, it wasn’t bringing in anything,” explains Michael Hirahara, SGI’s vice president of facilities. “We wanted to monetize these assets.”
So SGI brought in Cushman & Wakefield Inc.’s Michael Rotchford, senior managing director for structured finance, who helped put together a deal that allowed SGI to sell the seven office buildings for $276 million, lease back six and take the assets off its balance sheet—a big advantage to any company concerned with improving performance as measured by ROE. The most lengthy of these leases—one for four of the buildings—ends in 12 years, with subsequent options to renew and rents starting below market before escalating.
SGI is hardly alone. Thanks to low interest rates and high, but declining, property values, many companies—particularly victims of the high-tech implosion—are deciding to morph from landlord to tenant. Because most of these deals are private, no firm numbers are available on the scope of sale/leaseback activity. Real-estate experts, however, confirm a dramatic spike, and anecdotal evidence shows the biggest players getting their feet wet. Besides SGI, telecom giants Nortel Networks Corp. and Lucent Tech
nologies Inc. have also recently disposed of huge chunks of property only to subsequently lease back smaller pieces.
“We feel it is best for the company and shareholders to not have significant capital tied up in real estate,” says SGI CFO Jeff Zellmer. Even though actual cash flow turns negative in the face of the lease payments themselves, monthly lease expenses are offset by the recognition of the gain from the sale spread over the life of the lease, he notes.
Additionally, sale/leasebacks can pay off tremendously as far as costs of capital, says C&W’s Rotchford, who also recently did deals for CIBC and Phillips Lighting. Because the “arbitrage” versus the cost of obtaining funds through other sources amounts to as much as a couple of percentage points, Rotchford explains that these deals enable a company rated below investment grade to tap into funding at an estimated all-in cost of 200 to 250 basis points over Treasurys or near the current spread demanded by investors in triple-B-rated paper.
But while the benefit of this “arbitrage” is demonstrably greater in the case of lower-rated companies, the more solid corporate citizens can also realize savings using this approach if they involve partners such as real-estate investment trusts (REITs), which generally have more conservative investment rules prohibiting forays below investment grade. With this, “you have an arbitrage play, and you have a conservative investment play,” notes Craig Linden, director of investment sales at D.G. Hart Associates, a New York-based real estate brokerage and property-management firm.
Admittedly, after the Enron debacle, the four-word phrase “off the balance sheet” raises as many eyebrows as stock prices. But that’s why, as Rotchford asserts, you follow the letter and spirit of the applicable Financial Accounting Standards Board rules—mainly, FAS 13. This rule, affecting all sale/leaseback deals, imposes four tests necessary for off-balance-sheet accounting treatment:
• The deal can’t transfer ownership of the property