Business Management zone

Unlocking value in real estate. By Stephen Clarke.

Given current market conditions, companies should be looking closely at the role of their real estate portfolio. When traditional sources of finance are unavailable and cheap equity is hard to find, unlocking the value of real estate can be a valuable means of releasing capital.

At the same time group finance directors and property directors are seeking greater flexibility in their assets at less cost.

Operating companies can spin off property company structures and dispose of legacy estate (property belonging to the operating parent but not used) and is most commonly used by private equity firms as a tool in the boardroom armoury of the global corporates. Management is increasingly exploring these mechanisms for unlocking equity and driving down costs.

There are strong arguments for the separation of real estate holdings from a company’s operating business, as has been done in high profile deals, such as Sainsbury’s last year.



There is also an overarching desire amongst company occupiers to reduce the property lease cost base and to transfer off balance sheet the lease liabilities of their non-operational property portfolios and legacy estates. One solution is to package up and sell off lease liabilities, crystallising property risk and reducing cost, while maintaining flexibility. It is an increasingly popular option, with industry trade journal, Property Week, earlier this year speculating that up to £70m of legacy estate lease liabilities are about to be snapped up in a surge of activity in the property sector.

How it works

Legacy estate transactions see liabilities acquired by specialist property companies that can better manage the leases, allowing company occupiers to focus on their core business and operational estate needs. The key objectives in disposing of lease liabilities are to offload property risk, reduce the amount of time spent on managing them and to reduce the ongoing cost to the company.



While IAS37 provisions are made for surplus leases, there is a concern that companies are currently underprovided for and that these provisions will need to be increased. Under the rule companies must assess their value and add them to the yearly accounts. Often these valuations may be flawed and will only come to light during a sale, at which point the end-of-year report will show losses or write-downs on earlier assessments of value: something the boardroom wishes to avoid.

By disposing of the surplus lease liabilities during the year, the company is able to create a mechanism to crystallise and remove the IAS37 provisions through a one-off portfolio disposal, thereby removing future property market exposure and future lease liabilities. These are structured to ensure that there is no greater financial exposure to the company than if they had managed out the lease liabilities themselves.

There are a number of transaction structures available. A typical approach would involve the company establishing a special purchase vehicle (SPV). Since the leasehold liabilities are seen as a debt they are transferred into the SPV by way of assignment – meaning the SPV then has a negative value. The original holding company then transfers a cash sum equivalent to the reverse premium agreed with the bidder to the SPV, in many cases specialist property funds or asset managers. At the point of sale, the shares in the SPV would be sold for a nominal consideration. The illustration below outlines this approach:



Typically surplus lease liabilities are found in the financial services and retail sectors. These sectors have large property lease portfolios, which are increasingly redundant as technology or markets change. RBS is one of several banks to have disposed of surplus lease liabilities. CIS (Co-operative Insurance) is another to do so as a result of restructuring of its business. A number of high street retailers have disposed of portfolios of surplus lease liabilities as part of the repositioning of their brand.

Property advisors work with such companies to match their requirements with specialist legacy estate managers, such as Mapeley, Sparklestone (a joint venture with RBS), Legacy Portfolio, Land Securities Trillium, Asset Factor, Telereal and Burcote Liability Solutions. The managers mitigate lease liabilities, through surrender, assignment or sub-letting.

It is not the role of the company property team to act as letting agents for redundant property: specialists are far better at doing this.

Accounting for the change

By combining property and company finance expertise, advisors like DTZ are working with firms to overcome accounting issues that might once have acted as barriers to the use of this real estate solution.

For example, the transfer of lease liabilities crystallises the IAS37 provision, potentially leaving the company facing a large P&L hit if it has not adequately provided for the lease liabilities in the first place. Yet, in the event of under-provision by a company, the disposal payment and management terms can be structured in such a way that the P&L is no worse off than if the company had managed out the estate. This is successfully achieved through deferral mechanisms.



Additionally, there is a perceived tax issue, as any payment to a third party is deemed to be a capital payment and a reverse lease premium, which is not allowable for corporation tax. This need not be the case. The SPV route ensures that there is no claw back of previous tax relief. This mechanism is supported by legal opinion.

Finally, it is possible to put in place safeguards so that the leasehold liabilities transferred to the third party will not revert back to the company. This can either be achieved via the deferred payment route or through so-called credit enhancements such as bank bonds and parent guarantees and therefore need not be cause for concern.

In the current climate of driving down cost, effective and efficient property management is paramount. The SPV structure can eliminate exposure to the property market. It takes only a short time to set up and enables the liabilities to be ring-fenced and therefore more easily checked. With property so often the second largest cost after staff, companies must carefully examine whether they should be retaining legacy estates, particularly when there are 'buyers' in the market with an appetite for these portfolios.

Stephen Clarke is corporate finance director at DTZ. He is contactable on stephen.clarke@dtz.com. DTZ is a global real estate adviser operating across Europe, the Middle East and Africa (EMEA), Asia Pacific and the Americas. With a team of over 11,000 property professionals and a system operating across 140 cities in 45 countries, DTZ works with clients to provide innovative real estate, capital markets and business solutions worldwide.

This article was orginally published on Finance Week.

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