EUROPE NEWS: Private equity firms eye property liabilities

Private equity firms are considering paying specialists to take over portfolios of unwanted property leases belonging to their portfolio companies, and a number of such portfolios look set to come to market over the next six months.

“We are fielding more and more calls from private equity firms, as well as large corporations and investment companies,” said Adam Foster, whose Surplus Property Solutions took over 28 commercial leases from UK supermarket group Morrisons earlier this year. “While there have been a number of similar transactions over the past few years, including Rentokil, Wolseley and an RBS Equity Finance portfolio company, interest from private equity firms is just beginning to increase.”

Over the past five months alone, support services company Carillion, Richard Branson’s Virgin Media and Morrisons have completed transfers of lease liabilities totalling more than £200 million (€248 million; $316 million). They also have transferred management responsibility of their surplus property portfolios to lease liability specialists.

According to sources, one large private equity house currently is considering such a transfer, having appointed a property agent to advise on a deal. The identity of the firm, however, has been kept under wraps. 

“These recent transactions are the beginning of a new trend,” Foster said. “Unlike more traditional asset transfers, with leasehold liabilities added on in an effort to clean up house, the recent transactions are pure liability deals. 

What has changed – and is continuing to change – is that there is now an active market for leasehold liabilities. It is recognised that combining assets and liabilities in one transaction may not get the best price for either the asset or the liability.”

Matthew Stone, a partner in Cushman & Wakefield’s EMEA corporate finance team, said his firm has advised more than 30 FTSE-listed companies since the beginning of 2012 and just as many private equity-owned companies as they seek to concentrate on the growth of their businesses while removing the distraction of their surplus real estate. “Many companies have suffered the problem of sub-tenants and assignees going into administration or liquidation, resulting in property liabilities reverting to them that they had long since forgotten about,” he explained. “The profit and loss account uncertainty that this creates has driven companies to seriously consider a leasehold liability transfer to remove that uncertainty.”

In addition, the International Accounting Standards Board and its US counterpart, the Financial Accounting Standards Board, issued a paper in March 2009 outlining significant changes to the way leases are accounted for. The current notion of ‘operating leases’ is set to disappear, with all leases being capitalised on the balance sheet instead. No leases will be exempt, including leases signed before the changes are implemented. Currently, the changes are set to take effect in early 2016, putting enormous pressure on companies to find ways of reducing their exposure to under-utilised and unwanted leases.

Typically, to make a deal work, leases are bundled by the seller and transferred along with a reverse premium to the buyer. The buyer will then provide a guarantee, varying in size and security, and begin a workout of the leases. The seller might surrender properties to landlords, sublet properties, re-gear leases with sub-tenants or buy freeholds in order to add value and eventually make a profit.

Pesky leases

Rentokil was an early adapter of the transfer strategy

Rentokil, the UK pest control company, was one of the earliest examples of a large company transferring lease liabilities. In August 2006, it transferred 89 surplus leaseholds, six minor assets and a cash reverse premium to a buyer that guaranteed the liabilities would not return to Rentokil. The properties were mostly industrial units and offices, with some retail space. By the end of 2007, 65 leases had been surrendered, re-geared, let or expired, meaning Rentokil no longer had financial responsibility for the leases and the liabilities could be removed from its balance sheet. 

Not all the liabilities were so straightforward, however. In one example, Rentokil had a 100,000-square-foot warehouse in Scotland that was no longer of interest to logistics companies, so the buyer of its leases found a biomass company that was interested in converting the site. It got the necessary change of use, carried out the physical conversion and re-geared the lease once the new tenant had agreed to move in.  
By the end of 2009, of the original 89 leases, there were just seven fully-provisioned liabilities left.