Fixed-Asset Fix

With mergers creating more unwanted property, finance executives must come up with creative ways of unloading it.

With real estate investors pulling in their horns, some companies have found an alternative — sale/leasebacks — increasingly attractive. In such arrangements, a company sells a facility to a buyer, which leases it back to the seller. The buyer gets immediate income from the lease, as well as ownership of the property; the seller gets to move the asset off its balance sheet. Stancon of Cushman expects an increase of at least 15 percent in the number of new leasebacks this year.

Avoiding a Fire Sale

For a leaseback to be worthwhile, of course, the rental payments must be less than the potential earnings from reinvesting the proceeds of the asset sale. For that reason, Woodland Hills, California-based Litton Industries Inc., a defense contractor that has made frequent use of leasebacks, may prefer divestiture if it can sell a property for at least eight times the amount of potential lease payments, according to vice president and controller Carol Wiesner.

Also, leasebacks make sense only if a company wants to continue to use the property. If not, there’s little choice other than an outright sale. To avoid divestiture at fire-sale prices, companies like Schlumberger Ltd., an oil-field services and technology company headquartered in New York, and Fruit of the Loom have sought to redevelop property and lease it with the eventual aim of selling it to an income-oriented investor, or to find users in hopes that they will place a higher value on the property.

Both alternatives, of course, may require considerable time and expense. From that perspective, Fruit of the Loom was lucky. Its industry contains some 25 potential users, yet is intimate enough for Fruit of the Loom to know these users’ needs well. As McKay puts it, “Everybody knows everybody.” So Fruit of the Loom found it relatively easy to target its search to appropriately sized companies that needed extra capacity and would supply the raw materials it required. Even so, the process took as long as 18 months to complete. To get the most for the plants, the company focused on those producers it believed would pay a premium for a ready-to-go textile mill, instead of one they had to shut down and restart with new machinery on which they would have to retrain workers.

Despite the time involved, McKay contends the cost of its search was nominal. And he estimates that the company sold the plants for 10 to 20 percent more than it would have received had it simply sold them as brick and mortar.

Sometimes, developing a property for an investor can draw interest from users, as Schlumberger found with a facility in Ann Arbor, Michigan, that it finally sold in 1997. The facility, which included several buildings and excess land, was originally constructed for one user, a software development subsidiary that the company sold in 1992. To make the property more valuable, Schlumberger redeveloped it for multi-tenant use, which involved reducing the common space. Once it was fully leased, Schlumberger intended to sell out to an investor. Although the work cost $400,000, Gary Cozart, director of real estate, says rental income from tenants more than offset the investment. Plus, Schlumberger believed the building would be worth more to an investor if there were tenants.

It so happened that its largest tenant, the University of Michigan, needed more space. And Schlumberger’s development efforts helped convince the university that buying the property would be a good investment. The two parties agreed to a price of $13 million. Schlumberger meanwhile had subdivided the land from the buildings and sold it to Domino’s Pizza, which was headquartered down the street, bringing Schlumberger’s total proceeds to $17 million.

Cozart says that if the company hadn’t developed the buildings and sold the land separately, it would have received $6 million to $7 million less. And he suggests that other companies may have more opportunities to take advantage of land subdivisions than they realize. “In many cases,” says Cozart, “if you combine the land around it with a building, you’ll let the land go for a very low price.”

Outside Help

Some of Fruit of the Loom’s and Schlumberger’s efforts to sell surplus property have required extensive outside help from consultants, real estate brokers, engineers, and land planners. Yet, after relocating an oil-field research lab from Tulsa, Oklahoma, to Sugarland, Texas, Schlumberger found a user for the Tulsa property — the county health department — within six months, through some inexpensive public resources, the local chamber of commerce and economic development council. And, so long as recent M&A trends continue, corporate real estate departments are likely to call on outside resources of all kinds.

Jennifer Kruger is a freelance writer based in Hoboken, New Jersey.

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