New York-based CapLease, a real estate investment trust that purchases single-tenant net-lease assets, hasn't completed a sale-leaseback since April 2007.

Instead, CapLease has focused on strengthening its balance sheet while waiting for the credit markets to stabilize, says William Pollert, president of CapLease. The company owns a portfolio of some $2.1 billion in real estate and mortgages.

“Before the meltdown in the capital markets, everyone in real estate was on the crack cocaine of cheap money,” he adds. “Now the market is grappling with how to price risk in an economic downturn.”

Price hang-ups

Capitalization rates have risen between 50 and 200 basis points over the past year and range from 7% to 9%-plus, depending on the tenant's credit quality, the asset and location. An uptick in cap rates indicates downward pressure on prices.

New York-based W.P. Carey & Co., a sale-leaseback and build-to-suit investor with $10 billion in assets under management, is hunting for cap rates approaching 9% and higher, says Benjamin Harris, managing director and head of domestic investments for the company. He suggests that cap rates need to increase about 100 basis points in order for sales to boom.

“We've seen a definite pick up in sale-leaseback inquiries, but companies are reluctant to execute transactions for fear that the credit markets will get better three months from now,” he says. “But we don't see any reason why there would be near-term improvement. Companies will have to get used to where pricing is today.”

That's true to the extent that companies are desperate for financing. Since late last year, Philadelphia-based Pep Boys has completed $411 million in sale-leasebacks of its stores to reduce or retire debt, although it still owns 235 of 562 locations. The company won't be pursuing more deals soon because cap rates have increased from more than 7% to nearly 8%, says Ray Arthur, CFO of Pep Boys.

Motivated middle market

Unlike Pep Boys, stand-alone retailers, restaurants, and other corporations have made sale-leasebacks central to their business strategy. Crème de la Crème, a preschool owner and operator, has been using the structure since 2003 to accelerate growth, says Bruce Karpas, CEO of the Greenwood, Colo. company.

Crème de la Crème has executed 14 sale-leaseback transactions on 20 of its 21,000 sq. ft. preschools. It plans to add up to eight more schools by the end of 2009.

“Sale-leaseback transactions have always been a viable financing option for Corporate America,” says Jeff Hughes, a senior director with the Stan Johnson Co., a Tulsa, Okla., brokerage that specializes in net-lease transactions. “If you're building and selling widgets, you really shouldn't be in the real estate business.”

The credit crunch has nailed that point home for many corporations. In fact, small and middle-market companies with non-investment grade credit ratings — ratings below “BBB” — are pursuing sale-leasebacks and accepting today's lower sale prices compared with 18 months ago, say experts. While some property sellers are forced to enter into deal to generate cash, most view the structure as cost-effective.

But financially struggling corporations raise red flags, they warn. That's particularly true for businesses operating in the battered automotive, airline and housing industries, according to Fred Berliner, senior vice president and director of acquisitions at United Trust Fund (UTF) in Miami.