When The Sun Products Corp. decided to combine nine distribution facilities scattered across the Bowling Green, Ky. area into one giant center, an affiliate of W. P. Carey & Co. stepped in to provide $41 million in build-to-suit financing. The deal, which closed in June, illustrates how a growing company is able to secure financing for a new development despite turbulence in the capital markets.

Construction of the 1.4 million sq. ft. distribution center for Sun Products, a manufacturer and marketer of laundry and dish care products such as Wisk, All, Sunlight and Snuggle, is slated for completion in 2011. Johnson Development Associates Inc. based in Spartanburg, S.C., which has a long track record in the industrial build-to-suit arena, broke ground on the project this summer.

Upon completion, Sun Products will lease the facility from New York-based W. P. Carey (NYSE: WPC) for 20 years under terms of a triple-net lease. Located adjacent to one of Sun Products' four manufacturing plants in Bowling Green, the center will be one of two distribution facilities serving the entire East Coast for Sun Products.

Attractive financing vehicle

“These build-to-suit transactions, particularly in today's financing and economic climate, are really a win-win-win for the tenant, the developer and for us,” says Kathleen Barthmaier, director and member of the acquisitions team at W. P. Carey. “Neither the tenant nor the developer has to invest any of their own equity. That's why we're seeing this as an opportunity in the market now.” In the Sun Products deal, one of W. P. Carey's publicly held, non-traded REIT affiliates provided the capital.

Build-to-suit financing — a form of sale-leaseback financing — enables a company to expand an existing facility or construct a new building that is tailored to meet its needs. Rather than purchase an existing property as in a traditional sale-leaseback, W. P. Carey finances 100% of the construction costs and enters into a sale-leaseback agreement with the company upon the project's completion.

W. P. Carey is a huge player in this business niche. It specializes in sale-leaseback and build-to-suit financing for companies worldwide and manages a global investment portfolio of nearly $10 billion. The company's share price registered $28.30 at the close of trading Aug. 31, virtually unchanged from a year ago.

In one of the biggest sale-leaseback deals in recent memory, W. P. Carey and two of its publicly held, non-traded REIT affiliates paid $225 million for 21 floors, or 750,000 sq. ft of rentable space, at the New York Times Building in March 2009. The lease term was for 15 years.

At the end of 2008, The New York Times Co. had more than $1 billion in debt. The capital generated from the sale-leaseback transaction enabled the company to retire a portion of its long-term debt.

Building for the future

Consolidating nine distribution centers into one facility in Bowling Green and utilizing build-to-suit financing to do it is a smart business move by Sun Products, observes Barthmaier. “They are streamlining operations, saving money and not investing any of their capital [in the deal] so they can put it to use in their own business. It has all the benefits of a pure sale-leaseback transaction, with the addition that they get the facility they want and need.”

W. P. Carey generally seeks an internal rate of return in the low to mid-teens on transactions it enters into, Barthmaier says, and more for build-to-suit deals because of the inherent risks associated with construction. But she is quick to add that no two transactions are alike.

“We look at each deal based upon the credit of the company we're entering into a long-term relationship with, the quality of the facility, where that facility is located, how easily it would be to re-tenant that facility, and how important that facility is to the company,” emphasizes Barthmaier.

Although the credit rating of Sun Products, headquartered in Wilton, Conn., is below investment grade, says Barthmaier, it's overall “credit metrics” remain quite favorable. “They are a large, strong corporation.”

With annual net sales of more than $2 billion, Sun Products employs approximately 3,500 full-time workers. The company was established in September 2008 as a result of a merger between Unilever's North American fabric care business and Huish Detergents Inc. Sun Products is a portfolio company of private equity firm Vestar Capital.

Guy Lawrence, a public relations spokesman for W. P. Carey, says the $41 million in construction financing for the distribution center was a shot in the arm for Bowling Green and the surrounding area. “We like to think of ourselves as a catalyst in terms of economic stimulus at a time when maybe this deal couldn't be financed.”

Matt Valley is editor of NREI.

Industry braces for lease accounting changes

Proposed new accounting standards have been drafted in order to push lease liabilities back onto corporate balance sheets. Such a change would represent a major shift for companies that have typically favored the off-balance-sheet treatment of operating leases, and it could have a significant impact on corporate decisions to lease or purchase real estate in the future.

The proposed guidelines are a joint initiative by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board to create a uniform global standard and greater corporate transparency in lease accounting procedures. The most recent draft issued Aug. 17 would establish one method of accounting that requires firms to recognize all lease liabilities and assets on their corporate financial statements.

Another key component is that companies would be required to record the lease value or rent commitment over the entire lease term, including renewal options. Although the intent is to stop off-balance-sheet activity, the changes would add significant weight to corporate balance sheets.

For example, a firm that pays $1 million per year in rent for its corporate headquarters would quickly see its liability multiply depending on whether it has a five-year or 15-year lease. Companies would appear more highly leveraged, which could affect factors such as corporate credit and existing debt covenants.

Crux of the matter

What makes commercial real estate industry professionals nervous is that it is not clear to what extent the new accounting guidelines would influence tenants' decision-making process. Based on the universe of leased space, the potential impact is enormous.

Although FASB cites data that values leasing activity at $640 billion in 2008, other industry sources estimate that current volume as high as $1.3 trillion in operating leases for U.S. firms alone. Once the guidelines go into effect, which many in the industry believe will occur in 2013, both new and existing leases would be immediately affected.

One fear is that the new accounting practices could deter companies from signing long-term leases, or encourage firms to own rather than lease facilities. Both of those factors could be a detriment to the sale-leaseback and net-lease finance niche where leases typically extend 15 years and beyond.

Sale-leaseback transactions have accounted for $24.8 billion, or slightly more than 50%, of the $46.6 billion in single-tenant sales globally over the past 12 months from June 2009 through June 30, 2010, according to New York-based Real Capital Analytics (see table).

“I think there will definitely be a bias toward shorter-term leases in order to show less debt. But that is going to be offset by the fact that shorter-term leases are going to be more expensive, and landlords are still going to want longer-term commitments,” says Amie Sweeney, CPA, a senior financial analyst in corporate finance at Grubb & Ellis in Grosse Pointe, Mich.

Although long-term leases could become a disadvantage for some companies, many in the industry don't expect it to result in a significant decline in sale-leaseback and net-lease transactions.

“As long as companies can sell assets and lease them back and free up cash, net lease is still a viable financing source,” says James McCartney, CFA, managing director at Net Lease Capital Advisors in Nashua, N.H.

“To the extent that the financing rates are lower today, I don't know why someone wouldn't want to lock that up just because you're going to put that on your balance sheet,” adds McCartney.

Wait-and-see attitude

Ultimately, the impact of the new accounting changes on the commercial real estate industry is going to depend on the reaction by lenders, rating agencies and the companies themselves.

“We really don't know until we get these rules finalized, and get a full understanding of the reaction, what the impact of this is going to be,” says Randy Blankstein, president of The Boulder Group, a net lease advisory firm based in Northbrook, Ill.

“My guess is that investors and lenders will be slightly uncomfortable with the new debt levels, but not dramatically uncomfortable,” adds Blankstein.

FASB issued its exposure draft on Aug. 17. The draft was issued in order to solicit comments from the public. The deadline for comments is Dec. 15. The board will take those comments into consideration when writing its final proposal.

SINGLE-TENANT COMMERCIAL PROPERTY SALES (Past 12 months to June 30, 2010)

Over a 12-month period ending in June, 23% of all commercial property trades, or $46.6 billion in assets, have involved single-tenant properties.

Volume ($millions) % of Total # Properties % of Total
Americas $9,688 20% 581 31%
EMEA 28,789 88% 2113 45%
Asia Pacific 8,107 15% 177 18%
Global $46,585 22.6% 2871 38.2%
*Europe, Middle East, Africa Source: Real Capital Analytics