Opinion: Sale-Leasebacks Take Flight

While fundamentals seem to be in place for recovery from the COVID-19 crisis, the rapid commercial aviation rebound still presents challenges for suppliers.

Many suppliers have invested in technology and skilled workers to support the rebound, but soaring labor costs, higher interest rates and tighter lending criteria have created challenges to accessing the capital they need to fund these initiatives.

Just as many airlines free up capital through sale-leasebacks on owned aircraft, aviation suppliers can unlock the capital they need through executing sale-leasebacks on owned facilities.

A sale-leaseback transaction involves selling company-owned facilities and simultaneously leasing them back from the new owner. Proceeds can be used for acquisitions, investment in new production lines or de-levering or reducing the cost of capital.

Sale-leaseback transactions are particularly suitable for aviation companies, since many own their properties. Last year, EnCore Interiors—a subsidiary of Boeing that designs, certifies and produces airplane galleys and seats, as well as supplies product and components to Boeing—executed a sale-leaseback of its Southern California property with Brookfield. The deal freed up $35 million in capital. Additionally, in late 2021, Delta Research Corp., a manufacturer of high-precision production and prototype gear components and assemblies, executed a sale-leaseback on a portfolio of its properties in Michigan with Bridge Investment Group.

Last year was a record year for facility sale-leasebacks in both transaction volume (874 transactions) and dollar amount ($31 billion). Robust sale-leaseback activity in 2022 was driven by multiple factors, including buyers’ strong appetite to deploy capital, good arbitrage opportunity and sale-leaseback’s attractive cost compared to other forms of capital.

In 2023, the big sale-leaseback theme is that on a relative cost-of-capital basis, sale-leasebacks are even more appealing now than a year ago, making it a good time for suppliers to consider this financing option. The cost of corporate debt has risen more than 400 basis points in the last year, representing a doubling of interest costs in some instances. The cost of sale-leaseback financing has risen, too, but it has been much more muted (as measured by cap rates), widening approximately 100-150 basis points.

The idea of giving up control of real estate that is integral to a supplier’s business may make senior management uneasy, but doing so does not entail losing control of facilities that are essential to a company’s operations. The long-term lease component offers companies a similar level of control as if they still owned the property. A typical sale-leaseback term generally spans 15 years or longer, with renewals extending for an additional 20 years or more at the tenant’s option, providing effective control for at least 35-40 years.

There is more to raising capital through a sale-leaseback transaction than simply owning real estate, however. The health of the underlying business and its potential for growth are important factors, too. Investors value tenants who can fulfill obligations over the life of a long-term lease. Moreover, investors seek stability in companies, i.e., a strong balance sheet that can withstand fluctuations in earnings and sales.

Sale-leaseback transactions also differ from typical real estate deals because the location of the property does not play as big a role. A facility that is not located in tier-one metropolitan areas or prime locations could remain appealing and could obtain competitive pricing as long as the underlying business is healthy, since sale-leasebacks are more strongly dependent on the underlying credit of the company than real estate fundamentals.

Suppliers can utilize several levers to optimize sale-leaseback structure and value. These include the term of the lease, base rent and rent increases, among other items. Negotiating a change-of-control provision that does not obstruct an eventual exit or sale of the business is also crucial.

The arbitrage opportunity these transactions present makes them attractive, because owners have the option to sell their real estate at a valuation multiple that is frequently higher than the business valuation multiple.

The challenges aviation suppliers face now, such as rising demand, increasing material costs, supply chain disruptions and labor shortages, may continue for the foreseeable future. Unlocking capital tied up in real estate might be the key for suppliers to the aviation industry to keep up with these challenges.

Stephen Cheng, partner at SLB Capital Advisors, has more than 18 years of experience in real estate, including sale-leasebacks.