sale-leasebacks investments

NET LEASENET LEASE ADVISORADVISORFirst Quarter 2011

YOUR SOURCE FOR INVESTMENT REAL ESTATE™

COMPANIES, INC.

INDUSTRY EXPERT OPINION REPORTBy CALKAIN RESEARCH

Calkain Announces Calkain Announces 2010 Award Winners2010 Award Winners

S A L E L E A S E B A C K S S A L E L E A S E B A C K S A Franchise Owner ParachuteA Franchise Owner Parachute

COLLISION COURSE: COLLISION COURSE: Cap and Interest RatesCap and Interest Rates

CALKAIN COMPANIES, INC. N E T L E A S E A D V I S O R First Quarter 2011

Both investor appetite and seller tenant necessity sparked an uptick of sale leaseback activity in 2010. A growing number of franchisees exercised this option for the first

time since 2007 in addition to corporate-owned entities as a parachute to continue operations. Sale-leasebacks also sup-ported overall growth, stockpiling equity and restructuring ex-isting debt. Fortune 500 companies sold regional and national headquarters. Industrial conglomerates sold large distribution centers and portfolios of assets, respectively. Municipalities sought to lower deficits and balance budgets with government service assets by heading to the sale leaseback table.

Perhaps, the sector best realizing the value added with sale leasebacks were single and multi- unit franchise owners. Real estate could be a large portion of a franchisee’s equity invest-

ment and it may ultimately hinder their growth strategy. With lenders not availing themselves as regularly to operators with smaller bal-

ance sheets, then a monetization of the real estate currently in place could be an alternative solution option.

Since the economic downturn hit all sectors, many single and multi unit franchise owners found themselves facing closures and dissolution. Property ownership was no longer viable to the current business plan. Sale leasebacks have given extend-ed life to the franchisees needing immediate capital, flexibility and time to ride out the constriction or leap on sale priced expansion assets.

In 2010, sale leasebacks were used frequently by franchise owners for alternative financing vehicles to fund new store openings, maintain operation of current stores or invest in core businesses. During peak market conditions from 2005 – 2007, franchise sale leasebacks were some of the most coveted as-sets for investors. However, during the downturn, some were merely in a survival mode using equity to fund payroll and maintain inventory. The ability to redeploy otherwise illiquid assets was and is key for many franchisee’s survival and for oth-ers a well-timed growth and expansion opportunity. Multi-unit owners eliminated property ownership to simplify accounting and negate cross funding between stores with varied levels of sales and success and ownership structures.

There are numerous factors for franchise owners to consider with regard to transacting a sale leaseback, including the tax basis and possible penalties, corporate requirements and per-sonal guaranties potentially necessary to close the deal. Prop-er lease structuring is key to the longevity of the site as well as creating a salient asset for the ultimate NNN lease investor/buyer.

Teal Henderson | [email protected]

Phone: 813.282.6000

Let’s look at some of the franchise considerations and points of interest when contemplating a sale leaseback:

» Ability for immediate cash infusion for operations

» Use of equity for growth and expansion

» Continuity and uninterrupted operations and control of property

» Increase financial flexibility with creation of self fi-nancing and risk allocation

» Loss of depreciation but gain lease payment deduc-tions- proper structure of lease

» Some seller tenants have depleted their depreciation of property and thus there is less tangible and ac-counting benefit for retaining property

» Allows for restructuring, improving and simplifying balance sheets

» Bargaining opportunity for owner on lease options: buybacks, renewals, go dark options, assignments etc

» Preparation for a timed exit

» Ability for multi unit owners to sell numerous assets as a portfolio and negate multiple transaction fees

» Lowering costs with rent payments possibly lower than mortgage payments

S A L E L E A S E B A C K S S A L E L E A S E B A C K S A Franchise Owner ParachuteA Franchise Owner Parachute

By: Teal Henderson


COLLISION COURSE: COLLISION COURSE: Cap and Interest RatesCap and Interest Rates

Rates…our world is full of them. With cap rates falling and inter-est rates rising, just how much

lower can the spread between these two figures go before investors begin to push back? Consumer confidence has crept back to relatively normal lev-els, lowering demand for safe-haven US

t r e a s u r y bills and s u b s e -q u e n t l y d r i v i n g

the yield in an inverse direction. Com-mercial real estate seems to have bot-tomed out. Cap rates for net lease in-vestments stabilized in early 2010 and rapidly compressed over the following 12 months. As the economic world has changed over the past few years, rates and their relationships have changed

as fast as dollar store concepts are ex-panding.

It should come as no surprise to those actively in search of top tier assets over the past year that cap rate com-pression is very real. According to Calkain’s 4th Quarter 2010 cap rate report, net leased cap rates fell any-where from 50 to 125 basis points during 2010, depending on asset class and sector. Walgreens, often used as an industry barometer to gauge the overall world of cap rates, were real-izing average cap rates near 8% as of the end of 2009. 2011 unfolds, trans-actions for new construction Wal-greens are now nearing the 7% mark, with those assets in highly desirable geographic areas trading in the upper 6% cap rate range. As we dissect these

transactions to evaluate the driving factor pushing cap rates lower, the most apparent cause is the basic eco-nomic principle of supply and demand.

On the demand side, there has been a rise in activity from private individu-als searching for safe, passive invest-ments, while turmoil abroad has boost-ed the flow of foreign capital into US assets. At the same time institutional class investors, such as public and pri-vate REIT’s, are raising funds as fast as they can place them. Conversely, the supply side of the equation has shrunk drastically. (As the recession sunk in, tenants commonly occupying these net leased assets contracted, closing underperforming stores and choos-

By: Patrick Nutt

Continued...


CALKAIN RESEARCH

INDUSTRY EXPERT OPINION REPORT

AS A DEVELOPER, WHAT IS YOUR PREDICTION OF DEMAND FOR NEW MEDICAL CONDOMINIUMS IN THE WASHINGTON METRO AREA FOR THE NEXT YEAR OR TWO?

ABRAMS: There are several confl icting forces impacting the medical condo market over the immediate and near term. On the positive front, certain fi -nancing markets are becoming very attractive with practices able to borrow funds at about 5% and up to 90% of the project cost. This compares favorably with the cost to lease. Physician practices have also experienced generally good conditions compared to other aspects of the economy which have suf-fered worse over the past few years. For example you don’t hear about large layoff s by hospitals or physician groups. However, healthcare uncertainty - while better since the passage of the 2010 healthcare bill - still permeates the decision making process for individual practitioners.

AS YOU KNOW, THERE ARE SIGNIFICANT SHIFTS IMPACTING MEDICAL DELIVERY SYSTEMS: OUTSOURCED MEDICAL SERVICES FROM HOSPI-TALS, THE ADVANCING AGE OF THE BABY BOOMER GENERATION, THE RECENT HEALTHCARE LEGISLATION. CAN YOU COMMENT ON THE IM-PACT OF THESE TRENDS ON DEVELOPING MEDICAL BUILDINGS?

ABRAMS: We see a trend toward consolidating practice groups into larger sizes and toward greater hospital employment of physicians. Both of these trends point away from the condo model as a vehicle for physician occupan-cy. Larger groups tend not to own in this manner and hospitals tend to own entire buildings or lease space. We anticipate a greater orientation by health care systems to delivering services off campus in integrated settings where a variety of medical services are provided in a more unifi ed way rather than a building with a collection of unrelated physicians who may or may not be part of an integrated approach to care.

Michael Abrams is Pres-ident of Foulger Pratt Rockledge Medical

Properties, LLC, in Rockville MD, a major medical offi ce building development company in the metropolitan Washington DC area.

Formerly, Mr. Abrams was a principal at Rockledge Realty Partners. His twenty-year ca-reer represents a cross section of experience in real estate de-velopment, acquisition, fi nance and management on both a principal and third party basis. Prior to forming Rockledge, he served as founder and Presi-dent of Carey Winston Realty Advisors, an asset management and investment advisory sub-sidiary of the largest full service real estate company in Metro-politan Washington, DC.


GIVEN THESE TRENDS, WHAT IS YOUR PREDICTION OF DE-MAND FOR NEW FREE-STANDING OUTPATIENT, URGENT CARE, AND MEDICAL CLINIC FACILITIES?

ABRAMS: I think there will be a greater demand for these services but they will not be isolated from other services such as primary care imaging and other major practice types. Providers are being incentivized to provide “accountable care organizations” which are networks of hospitals and doctors with fi nancial responsibility for their care. This will likely reshape how doctors and hospitals physically organize and where they will locate. We anticipate a much more “retail” approach to the delivery of services under this model.

Winston Orzechowski | Research [email protected]

Phone: 703.787.4714

CALKAIN RESEARCH

» GW Medical Faculty Associates looks to add 450 doctors and buy 120,000 SF

» Inova Health System to add 200 more doctors

» MedStar completes purchase of Cardiology Associates

» Kaiser Permanente buys vacant build-ings in Tysons Corner and Gaithersburg

ALL PEDIATRICS | LORTON, VAPrice: $1,950,000 | Cap Rate: 7.67% Closed 4/2010

AFFORDABLE CARE | AUSTIN, TXPrice: $1,400,000 | Cap Rate: 9.40% Closed 11/2010

AFFORDABLE CARE | ANDERSON, SCPrice: $720,000 | Cap Rate: 10.34% Closed 11/2010

AFFORDABLE CARE | N. CHARLESTON, SCPrice: $1,047,961 | Cap Rate: 9.40% Closed 2/2011

RECENT MEDICAL

CLOSING

NOTABLE MEDICAL

TRANSACTIONS


Jerry Burg | Managing [email protected]

Phone: 703.787.4714

Andrew Fallon | [email protected]: 703.787.4714

SITUATION: The original developer of a new condo-minium medical offi ce building (MOB) recognized that he could achieve maximum return on his investment by selling the individ-ually leased condos to private investors. The property was well-located in Lorton, VA and select units had recently been leased on a long-term, triple net (NNN) basis to stable tenants.

OUTCOME: Calkain actively marketed the medical con-do property to our extensive database of triple net lease buyers and local investors. The property was introduced to purchasers who understood the unique opportunity and characteristics of medical offi ce condos. We highlighted the key attributes of the asset and were able to generate signifi cant buyer interest.

ANALYSIS: The property possessed what we consider to be key attributes of a core medical offi ce investment condo: landlord-friendly NNN lease terms; a strong and stable tenant; and excellent real estate fundamentals. The condo was leased to a successful pediatricians group and the building is an integral part of a community town center. Priced just under $2M, the asset was attractive to multiple investors.

RESULT: Calkain successfully identifi ed an investor who had an immediate 1031 requirement, and was capable of completing the transaction in a timely fashion. The procured buyer was a local investor who knew the new development and appreciated the reputation and strength of the pediatric practice tenanting the condo. The seller achieved his objective of maximizing returns and the buyer satisfi ed a 1031 exchange by acquiring a stable in-come producing asset in the Washington DC metro area.

The strong investment sales market in the Washington DC region often makes it challenging for private investors to find affordable, passive investment properties. The niche sector of medical office condos are becoming a popular option for private investors and 1031/1033 exchange buyers seeking income-producing assets priced under $2M. Medical office

condos carry strong characteristics in terms of strength of tenant, lease structure and real estate fundamentals.

Calkain was recently engaged by a medical offi ce building developer to sell triple net-lease medical offi ce condos in Fairfax County, VA. The successfully completed transaction benefi ted all parties.

CASE STUDY


Calkain Companies, Inc. is pleased to announce Jeff Bogart and Andrew Fallon as 2010 recipients of the prestigious “Top Producer” and “Rookie of the Year” awards, respec-

tively. Both have made invaluable contributions to Calkain and represent the highest degree of professional merit.

Jeff Bogart, displaying grace and humility, commented “I need to thank the entire Calkain team – without their help, this wouldn’t be possible.” A first time winner, Bogart’s years of experience and commitment to success have helped elevate Calkain to the position it enjoys today. Meanwhile, Fallon, demonstrating wisdom beyond his years, stated “This award represents a moment to savor but always build upon. Luckily I am surrounded by the perfect people with which to do so”. In one year with Calkain, Andrew Fallon has consistently ex-ceeded expectations and demonstrated an almost unequaled drive towards excellence.

Jonathan Hipp, Calkain President and Chief Executive Officer, added, “I am extremely happy for Jeff and Andrew. Their hard work and dedication are the building blocks Calkain’s success stands upon today. Calkain has always prided itself on its great team and I can think of no better representatives of the foun-dation we have laid. ”

David Sobelman | Executive Vice [email protected]

Phone: 813.282.6000

ing to remodel existing locations over expanding into new sites.) According to research from the In-ternational Council of Shopping Centers, the U.S. shopping center industry grew at its slowest pace in 40 years, expanding just 0.2% in comparison to 2006 growth of 3%. While discount retailers such as Dollar General continue to expand, other peren-nial net lease tenants remain hesitant. Even Wal-greens lowered their 2011 openings to just 50% of their 2010 figure. All signs point towards a general lack of supply throughout 2011.

While cap rates were falling, many speculated on the potential negative ramifications as benchmark 10-year treasury yield rose rapidly, gaining 75 basis points in the last two months of 2010. As of early February, that rate had increased another 25bps to 3.65% - the highest level since early 2010 - howev-er we continue to remain at historical lows across the board. Consider this, from July 1958 until the beginning of the recession in 2008, there has only been a two month period of time where the 10-year US Treasury provided a lower yield than today. In short, even with the recent rise in the yield on the 10-year note, over the past 50+ years that yield has been higher than where it stands today 98% of the time.

There will always be a gap between yields for “risk free” investments, such as the 10-year US Treasury and alternative assets, such as net leased proper-ties. Efficient markets utilize this higher yield or spread the price risk into an investment. Histori-cally, the risk premium for retail real estate assets hovers around 410 basis points according to New York based Real Capital Analytics. However, this spread has recently peaked at 540 basis points. As net leased assets fall under a more conservative, risk averse classification, they observe a lower risk premium. Calkain’s Cap Rate report measures the current spread for net leased assets, as of the end of 2010, near 470 basis points. The risk premium has continued to shrink as cap rates continue to fall, pushing closer to the historical norm. Howev-er, they remain a far cry from the 250 basis point spread observed at the peak of the market in 2007, when 10 year US Treasury yields varied between 4.10% to 5.10% and average cap rates were in the low to mid 7% range.

History has shown that the spread between cap rates and the treasury yield should thin out, but I think as we’ve seen, that compression will most likely be the move of both rates. Average cap rates continue to compress due to general lack in sup-ply. Treasuries will level out somewhere in the 4% range as the economy begins to heal and move forward.

Patrick Nutt | Assistant Vice [email protected]

Phone: 813.282.6000

Left to Right: Andrew Fallon, David Sobelman, Jeff Bogart and Jonathan Hipp

Calkain Companies, Inc. Announces 2010 Award Winners

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COMPANIES, INC.

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sale-leasebacks investments

Real Estate