UK Real Estate investment volumes have been in general decline since 2021.
Geopolitical and economic uncertainty have both contributed to wavering investor confidence, and consequently, would-be vendors have held back in wait for improving market conditions.
With inflation now beginning to stabilise from the hyperinflation of 2022/23, coupled with a 1% fall in the Bank Rate since July last year and a corresponding reduction in borrowing costs, expectations are that investment transaction volumes will start to improve through the second half of 2025. Indeed, transactional activity in the market could accelerate sharply as confidence grows.
Now presents a perfect opportunity for owner-occupier businesses to recapitalise effectively and promote growth through leveraging existing real estate interests. Here we take a look at some of the key considerations in the oft-talked-about world of Sale-and-Leaseback (S&LB’) transactions.
Understanding Sale-and-Leasebacks
S&LB transactions are a strategic financial option for many businesses aiming to optimise their real estate assets. Put simply, by agreeing terms to lease-back property, a business is able to free up significant capital to reinvest.
The Business Perspective
With no interest to pay and the ability to release 100% of the property value without LTV covenant constraints, S&LB is a cost-effective way to help fulfil expansion plans, reduce debts, and/or undertake vital operational upgrades, such as new equipment.
With an immediate liquidity gain and a predictable rental expense, it can also have a significant positive impact on cash flow management and forecasting. This, in turn, can have a positive impact on overall business value by virtue of an enhanced EBITDA, although be mindful that accounting standards mandate the disclosure of lease obligations on balance sheets, impacting financial reporting and potentially financial metrics. Long-term rental commitments could also result in higher cumulative costs compared to outright property ownership, particularly when considering service charges, maintenance and repair obligations, and so weighing up the opportunity cost is key.
Depending on the terms of the lease agreement, a business may be able to transfer responsibility for property maintenance, repairs, and risks associated with property value fluctuations to a new property owner, again contributing to improved cash flow through mitigation of operational and financial risks. It is important that businesses consider the condition of the property and have this documented adequately at the outset to avoid potentially nasty dilapidation surprises at a later date.
Lease payments are generally deductible business expenses, meaning a S&LB could substantially reduce the overall corporate tax liability and enhance financial efficiency, albeit there may also be capital gains tax considerations.
And, of course, businesses will benefit significantly from uninterrupted operations by remaining in their existing premises, thereby avoiding the disruptions and costs associated with relocation. Relinquishing ownership and management control will, however, restrict a business’s ability to influence future property decisions beyond lease terms. The prospect of non-renewal upon lease expiration presents a business risk which needs to be critically evaluated when negotiating terms at the outset.
Other points for consideration include the loss of future capital appreciation following property sale, with future gains benefiting the Landlord. Again, lease terms will dictate, but businesses may find that they have reduced autonomy regarding property use, modifications, and occupational arrangements, which could potentially restrict operational agility. This can all be navigated carefully with proper advice.
The Investor’s Perspective
Buyers can often be wary of S&LB transactions, which usually involve two types: (1) strong corporate businesses switching property strategies or raising cash for expansion/takeovers; and (2) struggling businesses desperate for a cash raise and a heightened risk of failing. First and foremost, it is important that buyers understand the purpose behind raising funds.
Understanding the business is also important. What are the opportunities and potential banana skins, and how does this align with a buyer’s risk appetite? Accounts of the business are crucial and can demonstrate the general health and act as a useful gauge for the performance of a business. If full accounts are not available, why is this the case, and what is it hiding? Do current management accounts show an improving position? What is the business plan for the next 2,3, 5 years?
Scrutinise the lease terms – are these in line with market norms or are there unusual inclusions/exclusions which could present a risk to your investment? Is there any flexibility in lease negotiations? Clearly, longer leases (especially where there is a strong covenant) is better.  What are the rent review provisions? Are they upwards-only to Market rent only? This might be acceptable in a rising rental market, but what if it is stagnant or in decline? An index-linked review mechanism might be more attractive and shore up investment performance over the duration of the term. Is the rent sustainable? A natural inclination might be to push rents to maximise capital value in the short term, but a lower rent may be preferential for the longer-term performance of the investment. If affordability is a concern, can a rent deposit be secured to help mitigate risk?
Finally, how much property information is available? Is it statutorily compliant? How energy efficient is it? What is the general state of repair? The more information that is readily available, the greater confidence can be given to an opportunity. A full suite of information will go some way to derisking a S&LB transaction and help to secure optimal bids.
Case Study
Watling Real Estate recently successfully completed the disposal of industrial premises in East Manchester via a S&LB transaction on behalf of a private client business. Following a review of several options, we were able to demonstrate that a S&LB was the optimum mechanism for raising the funds needed to implement a strategy to grow the business, whilst retaining occupation of their long-standing premises of over 25 years.
To maximise appeal to the market, we ensured there was a full pre-marketing suite of information readily available, with up-to-date statutory compliance certificates for health and safety, and new EPCs obtained to demonstrate improvements in the buildings’ efficiencies. Whilst loose leaseback terms were presented to the market, we were sufficiently flexible and able to negotiate amendments to the rental level and lease length in order to achieve the maximum sale price. We ensured our client had the protection of a schedule of condition and, by also offering a rental deposit, were able to agree on improved rental terms, whilst achieving an extremely positive outcome for the business.
Conclusion
S&LB transactions provide considerable strategic financial opportunities to businesses for capital release, cash flow improvements, and operational continuity. They also provide buyers with medium-long-term income and the opportunity for capital appreciation (often) without the headache of repair and maintenance responsibilities. Nevertheless, it is crucial that businesses and investors alike undertake robust due diligence and seek expert advice to help successfully navigate the S&LB road.
At Watling Real Estate, we recognise the critical importance of a thorough understanding of both the benefits and limitations of S&LB transactions. We have successfully advised on a number of S&LB opportunities within the past 12 months by combining our expertise in property restructuring and capital markets to provide a unique and balanced perspective to property owners and investors. We are committed to helping realise property ambitions and achieving optimal outcomes. If you would like to discuss a S&LB opportunity with us, please do not hesitate to contact one of our regional teams.
