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In a world of limited transactions, many companies are looking internally for ways to become more efficient and to create value. Non-traditional real estate companies in particular may find significant ways to unlock hidden value in their real estate portfolios. Many companies have great value in their real estate but are not recognized by the market for that value.  

Unlocking value refers to a strategy of helping companies release capital tied up in their real estate assets, usually through a sale-leaseback, asset-backed financing, or other structured transaction. The key is to monetize the value of the real estate portfolio while making sure that it is aligned with overall business needs, creating value for stakeholders and maintaining ongoing operating flexibility and control. A well-structured transaction may benefit the company in a number of major ways:

►    Increase liquidity
►    Help the company better align its strategy
►    Free up cash and efforts to focus on its core business
►    Potentially improve financial ratios and even increase market cap

While some of these ideas may seem obvious, many companies have real difficulty finding the time or resources to take a hard and strategic look at their real estate portfolios. But it is important nonetheless.  

While our focus today leans toward distressed companies (for example, struggling national retailers), it also applies to successful and profitable companies. For most companies, owning their own real estate ties up significant capital, usually without earning a direct return. Even if the assets appreciate in value, they are rarely monetized. However, releasing value from real estate can be used for funding growth, repaying debt, paying dividends or other general corporate needs.  

The real estate assets that are most attractive to investors and therefore easiest to monetize are usually part of a homogeneous portfolio and have some reuse option if the current user were to disappear. Retail, distribution centers, corporate headquarters and data centers are examples.

Assets that are too specialized may not be of interest, although that’s not always the case. Also, it may not be the company’s entire real estate portfolio being considered, but rather, a subset — a relatively homogeneous portfolio within the overall portfolio may be the best option to unlock value.
REITs and some funds, typical investors in this type of transaction, are looking for steady cash flow and long-term appreciation. They are often already set up to own and manage large portfolios.  In addition, today’s low interest rate environment makes these transactions attractive to institutional buyers.

Other considerations

We hear from a number of companies that their strategy of owning vs. leasing is based on the simple fact that the CEO prefers to own. While owning may inherently seem like the right thing to do, it is not always the right financial choice; on the other hand, it would also be problematic to free cash from the portfolio by selling real estate assets and then find out you’ve lost control or don’t have the flexibility you need to run and grow your business. Following that thought, there are two things that should be considered as part of any sales transaction:

►    Financial flexibility — the ability to dispose of unwanted leases over time.  A typical unlocking value transaction will take into consideration exit options, purchase options, substitution rights, financing terms and lease extensions.
►    Operational flexibility — the ability to continue operating within the building without undue interference from the landlord. A typical unlocking value transaction will take into consideration extensions of property use, external and internal property alterations, and redevelopment and reconfiguration options.

For most companies, owning real estate is a capital-intense activity that does not usually earn a direct return. Done properly and thoughtfully, a structured transaction should complement the company’s overall business strategy and free up capital to invest. Unlocking value provides the opportunity to restructure the company’s real estate portfolio to meet current and future business requirements while reducing risk, realizing capital investment, maintaining flexibility and enhancing shareholder value. And in this situation, investors may be able to earn a stable, long-term cash flow.

Brett D. Thompson is a principal with Ernst & Young LLP’s Transaction Real Estate practice. He may be reached at [email protected]. The views expressed are those of the author and not necessarily those of Ernst & Young LLP.