Property strategy: please re-lease me

Companies should be looking closely at the role of real estate given the
current worrying market conditions, because too much corporate capital is tied
up in property.

Back in 2007 real estate was at the centre of a number of high profile
corporate bids, such as that involving Sainsbury’s assets, and the arguments for
separating real estate from a company’s operating business were regularly
debated in the media.

Group finance directors and property directors alike are seeking greater
flexibility at less cost. Operating company/property company structures and
legacy estate disposals previously used by private equity are now commonplace in
the boardrooms of the global businesses, with management increasingly exploring
these mechanisms for unlocking equity and driving out cost.

There is an overarching desire among companies with property to reduce their
lease cost base and transfer lease liabilities of their non-used properties,
such as legacy estates, off the balance sheet.

One solution is to package up and sell-off lease liabilities, clearing up
your property risk and reducing cost while maintaining flexibility. It is an
increasingly popular option, with recent speculation suggesting that as much as
£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 manage the leases, allowing corporate occupiers to focus on
their core business.

The key objectives in disposing lease liabilities are to offload property
risk, reduce the amount of management time spent on managing lease liabilities,
and to reduce the ongoing cost to the business.

Although under IAS37 provisions are made for surplus leases, there is a
concern that businesses are not making enough provision for leases and funding
needs to be increased.

By disposing of the surplus lease liabilities during the year, the corporate
is able to create a mechanism to remove the IAS37 provisions through a one-off
portfolio disposal, ridding future property market exposure and future lease
liabilities. These are structured to ensure that there is no greater financial
exposure to the business than if they had dealt with the lease liabilities

There are a number of transaction structures available. A typical approach
would be establishing a special purchase vehicle. The leasehold liabilities are
then transferred into the SPV by way of assignment ­ meaning the SPV then has a
negative value. The vendor then transfers a cash sum equal to that into the SPV.
At the point of sale, the shares in the SPV would be sold for a nominal

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 is another to do so as
a result a 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 advisers work with such corporates to match-make 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 Burcott. The managers mitigate lease liabilities, through
surrender, assignment or sub-letting. It is not the role of the businesses’
property team to act as letting agents for redundant property: specialists are
far better at doing this.

Accounting for the change

Property specialists are working with clients to overcome accounting issues
that might once have acted as barriers to the use of this answer to managing
real estate.

For example, the transfer of lease liabilities could potentially leave a
business facing a big hit on the profit & loss account if it has not
adequately provided for the lease liabilities in the first place. Yet, in the
event of under-provision, the disposal payment and management terms can be
structured in such a way that the P&L is no worse off than if the business
had managed out the estate. This is successfully achieved through deferral

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, but 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 business.
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

In the current climate 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, you must carefully examine whether your business should retain
legacy estates, particularly when there are ‘buyers’ in the market with an
appetite for these portfolios.

Stephen Clarke works in DTZ’s corporate finance

Related reading