off balance sheet ownership structures

Simon Wainwright is a director of JohnPeiser Wainwright, Property Investment Ad-visers, based in London, UK. His practicespecialises in transacting investment businessthroughout the UK and Europe. He advisesinvestors and corporate clients on sale-and-leaseback programmes, the establishment oflimited partnership investment vehicles andother off-balance-sheet structures. He is due tolaunch www.offbalancesheetfinance.com, awebsite specifically devoted to monitoring ac-tivity and developments in this sector, later thisyear. In the last two years, his company hasundertaken transactions with a total value inexcess of e500m.

ABSTRACT

For many corporate occupiers, commercialproperty constitutes one of their largestoperational assets. With a desire to improveshareholder value and efficiency and to refocuson core business, the continued necessity toretain such assets on the balance sheet is nowunder challenge. Changes in accountancypractice and a desire to maintain flexibility are,however making the choices ever more compli-cated. This paper examines the current options

available for corporate users seeking to extractvalue from their property assets.

Keywords: accounts, balance sheet,capital, divestment, lease, leaseback,ownership, property

The decision by Microsoft, one of theworld’s most successful companies, topursue an exit strategy from the owner-ship of its global real estate portfolio mayat first seem surprising. As with manyother corporate occupiers, though, therationale is straightforward: why haveshareholder capital tied up in non-coreassets when that capital can be moreusefully and successfully deployed finan-cing the expansion of the company’s corebusiness, so achieving higher returns? Thefast pace of change and growth in the ITsector makes it particularly difficult to tieup capital for the long term in relativelylow-yielding illiquid assets. The principalrequirement is thus to preserve maximumflexibility; the Microsoft programme hassought to achieve this.

Many corporate occupiers lack abusiness- and property-linked strategy, and

Off balance sheet propertyownership structures

Releasing capital from operationalportfolios through divestment

Simon WainwrightReceived (in revised form): 7th March, 2000Simon Wainwright, Director, John Peiser Wainwright, 21–22 Grosvenor Street,London W1X 9FE, UK; Tel: �44 (0)20 7495 3728; Fax: �44 (0)20 7495 3729;e-mail: [email protected]

Journal of Corporate Real Estate Volume 2 Number 4

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Journal of Corporate Real EstateVol. 2 No. 4, 2000, pp. 330–342.�Henry Stewart Publications,1463–001X

have created an optimum lease term of10–15 years; flexibility can, however, bemaintained by the inclusion of tenant-only break clauses.

When confronted by a request torelease the capital that is tied up in acompany’s commercial property assets,Chief Financial Officers have historicallyhad two principal options: either to raisedebt against specific properties throughsecured loans or mortgage debentures,or to pursue a sale-and-leaseback pro-gramme. Raising debt appears directly onthe company’s balance sheet and in-creases gearing levels. To date, undertak-ing a sale-and-leaseback programme hasneither of these disadvantages, hence thepopularity of this method. In many cases,however, the capital raised through a saleand leaseback has enhanced the balancesheet at the expense of the profit and lossaccount. The principal advantages anddisadvantages are summarised in Table 1.

against this background the ‘default’strategy for property is to maintainmaximum flexibility. Flexibility, however,comes at a price, and many occupiers seemprepared to pay for a degree of flexibilitythat they will never use. Conversely, thoseoccupiers opting for more inflexiblemethods of occupation, such as the 25-yearlease, often have no exit strategy in theevent that their real estate needs changeover the lease period.

Most Chief Financial Officers are asmuch concerned about the impact of anoperational property portfolio on the profitand loss account as they are about reducingits impact on the balance sheet. In thiscontext, reducing the amount of surplusaccommodation is of paramount con-cern, as is reducing the impact of annualdepreciation charges. If anything, it isthese annual depreciation charges for fit-ting-out costs that have limited the desireto move towards shorter lease terms and

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Table 1: Secured lending versus sale and leaseback

Method Advantages Disadvantages

Secured lending/mortgage debenture

Sale and leaseback

1. Retain capital allowances2. Retain flexibility and control3. Interest payments are tax

allowable against P&L account4. Exposure to property market

capital growth

1. Off balance sheet2. Rental liability is not capitalised

(at present)3. Rental payments are tax

allowable against P&L account4. Release 100% of value5. No exposure to property market

capital risk — residual value etc6. No amortisation

1. On balance sheet2. Increases corporate gearing

levels3. Release �100% of value4. Need to provide for loan

amortisation over loan term5. Exposure to property market

risk (residual capital value)6. Capital tied up in an illiquid

asset

1. Loss of capital allowances2. Loss of flexibility and control3. Exposure to property market

risk (rental)4. Rental liability may be

capitalised on the balancesheet (proposed)

5. Loss of exposure to propertymarket growth (capital)

CONVENTIONAL METHODS

Secured lending or mortgagedebenturesThe easiest way to raise capital fromoperational property portfolios is to takeout a fixed-term loan, secured againstfreehold property assets. Offering thelender a first charge (either fixed or float-ing) on the property lowers the cost ofborrowing, and this method preserves theoccupier’s flexibility, as the loan can berepaid at any time, subject to break costs.The owner retains the benefit of thecapital allowances, and the interest ischargeable to the profit and loss account.However, the owner will not release100 per cent of the property’s value,the owner retains an exposure to theproperty market (capital value), and theborrowings remain on the balance sheet,thus adding to the company’s overallgearing levels.

Secured property lending is extremelycompetitive in the UK at present, withmany foreign banks actively seeking tobuild a loan book in this sector. Marginsof less than 100 basis points (1 per cent)

are common, and loan-to-value ratios canreach as much as 90 per cent in certaincircumstances. At the time of writing, theyield curve is relatively ‘flat’, with the costof capital peaking at around the 3–5-yearmark; thereafter the yield curve ‘dips’ forlonger terms — see Figure 1.

The desire to limit the impact on thebalance sheet, and to release 100 per centof a property’s value, has persuaded manycorporate owners to pursue the secondalternative, the sale and leaseback.

Sale and leaseback programmesIn the last 12 or 18 months many majorcompanies have actively pursued sale andleaseback programmes. Table 2 detailssome of the more prominent transactionsin the UK, although, as will be consideredlater, not all of these were on a con-ventional basis, some being off balancesheet.

What is perhaps surprising is the will-ingness that many companies still ex-hibit to enter into 25-year-plus operatingleases on leaseback properties, in the lightof recent changes in market practice,the absence of a long-term business plan

Figure 1 Moneymarket fixed-rate

sterling yield curve(June 2000)

Off balance sheet property ownership structures

32

5.00%5.20%5.40%5.60%5.80%6.00%6.20%6.40%6.60%6.80%

Base 3 5 7 10 15 20 25 30 40

Term (Years)

Rat

e

UK commercial property market, buttimes have changed. The glut of commer-cial property released on to the marketafter the 1980s development boom leftoccupiers in a strong position. In nego-tiating new leases, many were able tosecure five- and ten-year break clauses;15-year leases have now become thenorm in many sectors of the UK propertymarket.

The influx of American businesses intoEurope also assisted the campaign againstthe 25-year FRI lease. American cor-porate occupiers are already required tonote rental obligations under leases intheir accounts, and for this reason theyhave been keen to obtain shorter leaseterms or early break clauses. Microsoft’sleaseback of its offices in Dublin last yearis reputed to contain break clauses at thefifth and seventh years of the lease term.The author’s own company, John PeiserWainwright, was involved with the saleand leaseback of Conoco’s UK head-quarters some 18 months ago, which wasundertaken on a conventional basis but

and the proposed changes in AccountingStandards.

The proposed changes in AccountingStandards, which are still at the discussionstage, propose to capitalise rental obliga-tions under operating leases and includethem on the balance sheet as both an assetand a corresponding liability. If theseproposals become established practice,which is considered likely, many of the offbalance sheet advantages once afforded bytraditional property sale and leasebackswill be removed. The capitalisation oflease rental liabilities will increase cor-porate gearing levels as much as retainingownership and raising mortgage debt. So,are there any reasons to consider a saleand leaseback? What is the rationale forstill undertaking such transactions? Whatare the alternatives?

25-year occupational leasesFor many years, the 25-year full repairingand insuring (FRI) occupational lease,incorporating five-year upward-only rentreviews, has been the cornerstone of the

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Table 2: Recent UK sale-and-leaseback transactions

Company Size Yield Sector Location

MicrosoftMicrosoftProcter & GambleIBMAXA Sun LifeNissho IwaiDellMFIConocoWH SmithShellHalifaxHolmes PlaceJ SainsburyBHSAccor

£44m£100m£80m£60m£51.8m£25m–£30m£25m£108m£35m£40m£300m£15.5m£12.5m£335m£14.5m£108m

7.0%

7.0%6.5%6.5%

6.0%8.25%7.2%

7.5%7.25%7.0%7.0%

OfficesOfficesOfficesOfficesOfficesOfficesOfficesRetailOfficesRetailForecourtsOfficeLeisureRetailRetailHotel

DublinReadingBrooklands, SurreyLondon SE1Old Bailey, London EC4London EC4Bracknell Boulevard10 storesWarwick Technology ParkPortfolio — UK180 petrol forecourtsLondon EC3London suburbs16 supermarkets3 storesLondon suburbs

contained a break clause at the twelfthyear of the term.

Many corporate occupiers, particularlyUS corporations, are reorganising theirproperty portfolios on a pan-Europeanrather than a country-specific basis. In aEuropean context, leases in excess of tenyears are the exception rather than therule, and annual rental indexation is morecommonplace.

In the UK, the only sectors where the25-year lease continues to be popular arein the retail, hotel and leisure sectors. It isthe strong demand and limited supply ofnew opportunities caused by a restric-tive planning system that perpetuates thissituation in the UK. Yet even in thesesectors there are signs that occupier resis-tance is emerging. In a series of recentcompetitive tenders, it was noticeable thatDavid Lloyd Leisure were offering a max-imum lease term of 15 years and compen-sating by offering higher rental terms thansome of their competitors.

Many investors have recognised thistrend and are prepared to pay premiumprices for properties let on 25-year leases,assisted by the lower cost of finance at thisend of the yield curve. The message isthus clear: the days of the 25-year lease arenumbered. Against this background, let usfocus on the issues that are relevant to thecorporate occupier in extracting valuefrom corporate property assets.

ACCOUNTING STANDARD FRS-12

Provisions, contingent liabilities andcontingent assetsThese provisions came into effect on23rd March, 1999 and affect only thoseleases that are considered to be liabilitiesas opposed to assets. In practice, FRS-12is most likely to affect leases wherethe rental obligations are above currentmarket value (ie the buildings are over-

rented) and the tenant does not occupythe buildings. The extent of the netliability, including any potential dilapida-tions claim, is capitalised in the accountson a present value basis. In practice, thisis merely an extension of the provisionsbrought in during the mid-1980s, whichput an end to ‘finance leasing’.

While these provisions are sobering,they do not at present make any impacton sales and leasebacks at market rentalvalue. The proposal from the Account-ing Standards Board is, however, thatall operating leases be treated the same,and that the contracted rental stream iscapitalised and included on the balancesheet as both an asset and a liability. Anoperating lease is defined as any leasethat is not considered to be a financelease.

Thus, where a lease is at an openmarket rental value, the minimum con-tracted stream of rental payments for theduration of the term, or to the nextbreak clause, is reduced to a present-day value by discounted cash-flow tech-niques, and this figure is included on thebalance sheet as a liability. Similarly,where the property has a market value,the capitalised value of the occupancyrights under the lease (the rental valueof the property) can be included on thebalance sheet as a corresponding asset. Inthe case of certain retail properties, thelease may have a premium value overand above its rental value (otherwiseknown as ‘key money’), although oc-cupiers would be unwise to include sucha sum on the balance sheet as an asset,as such sums are notoriously uncertain,variable and volatile.

While the sale and leaseback would stillrelease hidden capital, the principal ad-vantage of this method is in the non-recognition of the future rental liability ona company’s balance sheet. If the Ac-counting Standards Board’s provisions


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balance sheet until FRS-13 was adoptedin 1999.

Falling interest rates in the 1990s causedsubstantial increases in property values.Many companies were quick to revalueproperty assets in their accounts. The factthat the same property assets have beenfinanced through fixed-rate debt, whichhas higher break costs due to fallinginterest rates, has hitherto been ignored.FRS-13 addresses this, requiring com-panies to mark their loans to market andto disclose any such liabilities on thebalance sheet.

So, what are the alternatives to secureddebt or mortgage debenture, or sale-and-leaseback programmes? How can flexi-bility be preserved, and debt removedfrom the balance sheet?

OFF BALANCE SHEET VEHICLES

Accounting considerationsIf a company owns 50 per cent or less ofthe share capital of a subsidiary it does nothave to consolidate the liabilities of thatsubsidiary on to the parent’s balance sheet.If the parent owns 25 per cent or more ofthe share capital of a subsidiary and exer-cises a degree of control, a note of thesubsidiary’s liabilities still needs to appearin the parent’s accounts, although theseare not consolidated on to the parent’sbalance sheet and will not affect its gear-ing ratios. The current debate concerningequity accounting may of course affectthis at some future date.

The possibility therefore currently ex-ists for a corporate occupier to create aholding vehicle, into which it transfersits property assets. It can then gear orleverage the subsidiary to the maximumon a non-recourse basis, and, provided itdisposes of more than 50 per cent of theequity, the debt need not be consolidatedon to the parent’s balance sheet.

are implemented this advantage wouldbe negated, although in most casesthe liability for rental payments wouldbe balanced by a corresponding as-set value for the occupancy rights. Inthese circumstances, there would be fewadvantages to be obtained from a sale-and-leaseback programme over releasingcapital through secured loans or mortgagedebentures, as each will have a similarimpact on the company’s disclosed levelsof indebtedness (‘gearing’).

It is worth pointing out that theseprovisions do not in themselves alter theoperating efficiency of an affected busi-ness, merely the basis of its financialreporting. In determining the value andworth of a given business, analysts shouldalready have accounted for, or discounted,its operational property portfolio and itscosts or asset allocation. The provisionsmay, however, flag up certain facts abouta business that were previously hidden,particularly in relation to gearing levels;in this context, retailers are most sig-nificantly affected as the changes coulddowngrade credit ratings and even rendercompanies in technical default of theirloan covenants.

ACCOUNTING STANDARD FRS-13

Disclosure of derivatives and otherfinancial instrumentsWhere companies seek to release hid-den equity through a secured debt ormortgage debenture programme they arenow subject to the provisions of FRS-13.In structuring debt in this way, a bor-rower will normally seek — and a lenderwill normally require the borrower — tocontrol risk through the use of interestrate derivatives. Regardless of whethersuch derivatives were classified as an assetor a liability (dependent on the move-ment in interest rates, they remained off

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Simultaneously with the property trans-fer to the holding vehicle, the corporateoccupier can lease back the propertiesto its various operating subsidiaries. Theleaseback term could be for a term of, say,15 years, with the possible inclusion ofbreak clauses. In this way, the operatingsubsidiary can avoid the potential pitfallsof having to capitalise long-term leaseliabilities. The downside of the shorterlease, or the inclusion of breaks, is that thevalue of the property will not be maxi-mised and the borrowing and amortisationcosts will be higher, thus leading to higheroperating costs.

The prime motivation for restructuringthe balance sheet in this way is the desireto release capital that is tied up in opera-tional property assets and increase com-petitiveness, not merely as a responseto changes in accountancy practice. Asecondary motivation is the desire toachieve greater flexibility and agility inresponse to the increased rate of changeexperienced in many sectors, particularlythe IT sector.

Legal forms of co-ownershipWhat are the legal forms such co-owner-ship vehicles can take? The principaloptions are:

— Limited company— Partnership (limited or general)— Unit trusts (authorised or unauthor-

ised).

For off balance sheet co-ownership vehiclesto prove attractive to a wide variety ofinvestors, they should strive to achievetax neutrality and limited liability (limitedrecourse) for all parties. It is for this reasonthat the limited partnership structure is cur-rently proving to be the most attractivelegal form for such co-ownership vehicles.A Bill currently before Parliament shouldintroduce a further form of partnership,

the limited liability partnership, in 2001–02;the difference between this and limitedpartnerships is examined below.

LIMITED PARTNERSHIPCO-OWNERSHIP VEHICLES

Limited partnerships: Tax efficiency— limited liability — controlA limited partnership (LP) is in most casesconsidered to be a collective investmentscheme. It is a long-established legal struc-ture, dating back to 1907 in the UK, andachieves both tax transparency and limitedliability for investors. Unlike a generalpartnership, it has to be registered andrequires a Financial Services Act registeredmanager.

One of the advantages of this structure isthat the corporate occupier can retain con-trol of the investment vehicle, by setting upa specific subsidiary company to act asgeneral partner, and appoint an independentAsset Manager. This is particularly usefulwhere operational space is being sharedwith income-generating space. Whether ornot the co-investor would be prepared toaccept such a potential conflict of interestis of course another matter. In addition, ifthe degree of control remaining with thecorporate occupier is the same as withownership, this could inadvertently bringthe structure back on balance sheet.

In contrast, if the corporate occupierremains a limited partner, it is not permittedto take part in the day-to-day running ofthe partnership. A limited partnership canalso be structured to allow the corporateoccupier a re-purchase option after a fixedperiod; provided this is merely a ‘call’ asopposed to a ‘put’ option, it need notappear on the balance sheet as a contingentliability.

Through the impact of gearing orleveraging, and by permitting access to anumber of investors, limited partnerships


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remain the preferred form of propertyco-ownership vehicle.

Access to capital marketsIn creating an off-balance-sheet structure,corporate occupiers may also have theadvantage of being able to utilise thecapital markets to reduce the overall costof borrowing and thus to increase returnson the equity remaining in an invest-ment vehicle. The technique of issuingbonds against the security of assets andan income stream (otherwise known assecuritisation) is commonplace in otherindustries and is starting to achieve ac-ceptance and more widespread use in theproperty markets. Again, the costs as-sociated with this technique make it inap-plicable to lot sizes below £100m; themajor advantage is access to cheaper capi-tal and hence reduced operating costs.

Table 3 illustrates the way in whichstructured finance works to provideequity investors with enhanced returns. Inconsidering the ratios applicable, the keyconsideration is the investor’s attitude torisk, and the example in Table 3 is closeto the limit of what can be realisticallyachieved through conventional finance. Inmany cases, the bank providing debtfinance may also take an element of theequity/mezzanine finance, and can makean additional margin by securitising themortgages as part of a larger portfolioby issuing commercial mortgage-backedsecurities (CMBS). If the transaction is

do not suffer from capital size restrictions,and can accommodate large as well asdiversified portfolios of property. In prac-tice, they are unlikely to be viable for lotsizes below £50m.

Limited liability partnerships — A newvehicleAs limited partnerships date from 1907,they are long overdue for an overhaul. ABill currently before Parliament shouldintroduce the limited liability partnership(LLP) in 2001–02. This should overcomethe following drawbacks that limitedpartnerships have suffered from, namely:

— LPs are limited to a maximum of 20partners, whereas LLPs will have nosuch restriction.

— LPs are barred from participating inmanagement, whereas there will be nosimilar restriction on LLPs.

Final confirmation that LLPs will be taxtransparent is still awaited; however, fora variety of reasons they are unlikely tobe suitable for listing. The propertyindustry has long campaigned for theequivalent to a US-style real estate in-vestment trust, and it remains to be seenwhether LLPs will provide this, by acci-dent rather than design. For the timebeing, it would appear that both LPs andthe new LLPs will be unsuitable for astock exchange listing, and until thenew Bill has been enacted the LP will

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Table 3: The gearing benefits of structured finance

Tranche/ratios Capital Interest/rent Interest rate/return

Senior debtMezzanine/equityProperty totalLoan-to-value ratioInterest: Income cover

£90m£10m

£100m

£6.3m£1.2m£7.5m90%

119%

7.0%12.0%7.5%

sufficiently large and the time-scale per-mits, the proceeds of the securitisation canbe introduced directly into the investmentvehicle, passing on the benefit of thecheaper finance available through thecapital markets to the occupier.

Segmenting riskOne of the downsides of a sale-and-leaseback transaction, from the occupier’sperspective, is an exposure to potentialincreases in the market rent every fifthyear of the term, at rent review. Oneway around this is to structure fixedrental increases throughout the term. Thiseliminates this element of uncertainty forthe duration of the leaseback term andgives both the occupier and the investorsgreater cash-flow certainty. The investor isthus purchasing a fixed-term cash flow,together with the risk of an uncertainresidual value following the lease expiry.The occupier will of course retain anultimate exposure to open market rentsupon the lease expiry.

A further approach that can be adoptedin the segmentation of risk is to sell onthis residual interest in the propertywhich follows the expiration of theoccupational lease to other investors, inthe form of zero dividend bonds. Whilethe potential upside in terms of futureresidual value remains unlimited, thedownside of a fall in value can becapped, by the use of residual valueinsurance policies or guarantees. Thisresidual interest can of course be thesubject of an occupier’s right to repur-chase at market value by either ‘put’ or‘call’; it will be appreciated that a ‘put’option may be classified as a contingentliability on the balance sheet.

In these ways the various risks attachedto occupation and ownership can be seg-mented, measured and controlled in orderto achieve a lower overall cost of capitaland hence lower operating costs.

Tax treatmentWhile offering tax transparency, thelimited partnership has a number of othertax benefits and quirks. These relateprimarily to stamp duty and capital gainstax, which are examined below.

Stamp DutyIt has been noticeable in the UnitedKingdom property market that transactiontax or stamp duty has increased sig-nificantly since the Labour Governmenttook office. Stamp duty in the UK cur-rently stands at 4.0 per cent for propertytransactions that have a value in excess of£500,000. This figure, combined withlegal and agents’ fees, gives rise to acommonly quoted figure for ‘acquisitioncosts’ of 5.7625 per cent.

In comparison with the level of transac-tion taxes elsewhere in Europe, the levelapplicable in the UK is still quite low, asTable 4 demonstrates.

In contrast to the transaction tax onproperty (4.0 per cent), the transaction taxon share transfers is 0.5 per cent. There istherefore a movement in the UK toensure that property assets are held ina more liquid form or in more liq-uid vehicles. One of the side effects ofmoving corporate assets into off balance


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Table 4: Transfer taxes in Europe

Country Transfer tax %

BelgiumFranceGermanyItalySpainSwedenThe NetherlandsUnited Kingdom

12.54.8*3.5

10.06.03.06.04.0

*Note: France was 18.6% until January 1999

partner no longer owns. The downside ofthis is that a capital gains tax liabilitycan arise for existing partners each timeeither a new partner joins or an existingpartner leaves, where their share percent-ages change as a result. If the profit-sharing ratios do not change, the impactof capital gains on the remaining partnersshould remain unaltered.

As the use of limited partnerships asproperty investment vehicles has onlyrecently become more popular, manytax-related issues have yet to be con-sidered in depth by the Revenue.

IncomeEach partner is taxable on its share of theincome or gains arising from a partner-ship in a given year. Due to the tax-transparent nature of partnerships, grosstaxpayers such as pension funds are notprejudiced by the tax obligations of otherpartners. As there would be no benefit fora corporate occupier to pay rent to itself,the objective of structuring a limitedpartnership must be to obtain maximumleveraging in order to minimise any surplusincome after debt service and amortisa-tion.

CASE STUDY: PROJECT REDWING

J Sainsbury plc and Highbury FinanceThe retail sector has been at the forefrontof the move towards property divestmentprogrammes. J Sainsbury plc announcedthe intention to set up such a vehicle,codenamed Project Redwing, in October1999 and successfully concluded a transac-tion in March 2000. The deal involvesmany of the techniques discussed in thispaper and was structured as follows:

— The transaction involved the sale of aportfolio of 16 stores to an offshorespecial project vehicle (SPV) and raised

sheet structures is the potential to savefuture stamp duty when divesting fromthe equity in such ownership vehicles. Itshould, however, be stressed that limitedpartnerships do not have any potential fora stock exchange listing, and the secon-dary market in partnership shares can beboth limited and illiquid.

The disparity between property andcorporate transaction taxes, together withavoidance mechanisms, is something thatis currently under investigation by theRevenue. For the time being, savingswould appear to be achievable, providedthe purpose of the entire structure cannotbe shown to be stamp duty avoidance.

It is possible that any changes in respectof stamp duty legislation will relate totransfers taking place through corporatevehicles within the UK. Ways are stilllikely to exist which mitigate stamp dutyliabilities though the use of offshorevehicles and by dividing ownership be-tween its legal and beneficial interests. Fora multinational corporate occupier pursu-ing a global or pan-European approach toits property assets, many possibilities existas to the country of domicile for itsproperty-holding vehicle.

Capital AllowancesThe position concerning capital al-lowances in limited partnerships isuncertain, and is still open to interpreta-tion by the Revenue. It should, however,be possible to make a case for a 50 percent owner to claim 50 per cent of theavailable capital allowances on propertyassets on a ‘pass-through’ basis.

Capital GainsIn terms of tax considerations, where anew partner joins or leaves a partnershipand causes a change in partnership profit-sharing ratios, the Revenue treats eachpartner as having disposed of the fractionalpart of the partnership assets which that

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Table 5: Retailers: Land values and capitalisation compared

Company

Land andproperty value

£m

Marketcapitalisation

£m Ratio %

TescoKingfisherDixon GroupMarks & SpencerJ SainsburyBootsGreat Universal StoresSafeway (UK)Morrison (WM)NextMatalanSignet GroupWH Smith GroupN Brown GroupDebenhamsJJB SportsIceland GroupSomerfieldSelfridgesDFS FurnitureBrown & JacksonCarpetrightT&S StoresBody Shop InternationalGreggsMFI FurnitureStorehouseCourtsNew LookWickesClinton CardsWyevale Garden CentresArcadia GroupFine Art DevelopmentHouse of FraserThorntonsAlldersHarvey FurnishingsBlacks LeisureBudgensGrampian HoldingsMoss Bros GroupAlldaysSave Group

6,0302,060

732,6705,000

854313

3,0801,050

881549

18914

50618

252819292434538244341

356412106233415

10435231

2734086192364491577

195

12,4408,1807,1106,9506,2005,4603,5402,0201,9401,9101,1101,050

99393266964247841635434834033927525923423222722222020719519117615613412610810410110099793127

48251

3881169

15254515

192

763

53197821213119

1718

1531814810168

5420020

20432801823644919

248722

Source: The Times 4th December, 1999; Datastream

historically comprised, as much as 96per cent of the company’s net bookvalue. Table 5 highlights the issue of onbalance sheet property assets across theretail sector and indicates the vulnerabilityof many of these companies, unless thisissue is addressed. The one caveat is thatmany of the figures provided in companyreports and accounts are historic and maybe wildly optimistic, thus overstating theposition.

CONCLUSIONS

The drive towards the more efficient useof capital is on, with most companiesfocusing on their core business. In thiscontext, the necessity to retain operationalproperty on the balance sheet is thesubject of much debate. Retailers whoseproperty portfolios represent a significantproportion of their market capitalisa-tion have realised their vulnerability topredators anxious to unlock latent value.The simple choice between on and offbalance sheet finance is now complicatedby the proposed changes in accountingstandards. Against this background, con-ventional sale-and-leaseback transactionsare metamorphosing into complex struc-tured finance deals; J Sainsbury’s ProjectRedwing with Highbury Finance can beseen as a vanguard, with many otherretailers looking to follow suit.

Not everybody agrees that this is the wayforward; previous transactions, such as theTesco/British Land venture, have encoun-tered difficulties. Some argue that withborrowing costs at a 30-year low it is betterto preserve total flexibility, to retain owner-ship and opt for on balance sheet debt,provided gearing levels are not an issue. If capitalis an issue, then it is important to assesspriorities and balance short-term needsagainst the long-term commitments of sale-and-leaseback transactions.

£340m.— The funds raised will be utilised by

J Sainsbury plc to develop newHomebase stores and to finance theretailer’s e-commerce plans (core busi-ness).

— The leaseback to J Sainsbury plc is fora term of 23 years.

— The leaseback rent of approximately£25m per annum equates to £254 persq m (£23.60 per sq ft) and is notsubject to open market rent reviewsbut rather to an annual indexation of 1per cent per annum, giving a fixedincome stream.

— The acquisition was largely financed byissuing fixed-interest bonds offering a 7per cent coupon. As the SPV issuingthe bonds is offshore, payments un-der the bonds are more tax efficient,reducing the cost of capital. The bondsare partially self-amortising, and thedebt falls from £340m to £170m atthe end of the 23-year term.

— While 16 stores are pledged as securityfor the bonds, a further nine pre-agreed stores have been agreed assuitable substitutes, in the event that JSainsbury plc need to sell or redevelopany of the original 16 properties at anytime during the first 21 years, subjectto a valuation test.

— At the end of the 23-year term, theoutstanding debt of £170m will befinanced through the sale of the stores.J Sainsbury plc has a first option toacquire the stores at market value. JSainsbury plc has guaranteed to under-write any loss if the properties fail toachieve a sale price of £170m and willshare in any excess profit above the levelrequired to repay the bonds. Alterna-tively, J Sainsbury plc can take a new20-year lease on the properties.

The deal is important for J Sainsbury plc,whose property assets it is estimated have

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What is clear is that those organisationsthat have a linked business and propertystrategy will have a clear competitive ad-vantage over those that do not. Thoseorganisations that have achieved this willknow where to pay for flexibility; thosewithout a linked strategy may pay forflexibility but never use it. The operationalcosts of those organisations without thelinked strategy will therefore be higher thanthose with an occupational plan; in the longrun, they will be less competitive.

With most major corporations review-ing their occupational property require-ments, the difference between the US andEurope is relevant: it is estimated that in

the US corporate occupiers own around18 per cent of the property they occupy,whereas in Europe the figure is closer to70 per cent. For the large quantities ofcapital seeking suitable investment-gradestock across Europe, the outsourcingof operational corporate property assetsseems their natural quarry.

The J Sainsbury deal would appear fromthe occupier’s perspective to be a case of‘having your cake and eating it’. If so, itis likely that we will see many variantsof this transaction in the months ahead.Such transactions are still in their infancy,and many Chief Financial Officers will bewatching developments with interest.


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off balance sheet ownership structures

Business