A Look at Property Ownership Structures – Mark Sheehan, Managing Director, comments

June 24, 2008

Historically, it has been seen as fundamental by much of the leisure and hospitality sector to own the property in which the business operates. In particular, pub and hotel operators have, traditionally, nearly always owned the property from which they traded. As these markets have matured, it has become commonplace for operators to trade out of property that is leased rather than owned. Over the past decade or so, a number of operators have realised that the value of the property in isolation can be worth as much as, and sometimes more than, the combined freehold operating business. As such, several owner-operators have unlocked value by selling property for development, and through sale and leaseback.

As the property market has become increasingly inflated, this arbitrage has grown so much that many owner operators have been forced to consider unlocking property values. Quoted companies with significant property assets in particular are virtual sitting ducks to both private equity purchasers and entrepreneurial property players, and if the existing owners or shareholders don’t consider doing so, someone else may well come along unlock their property value.

Ways and means to unlock value

In 2007 the Government introduced Real Estate Investment Trusts (REITs) with tax benefits for Propcos that met specific criteria. Initially, there was some ambiguity around how this would apply in practice, and there was widespread anticipation that these criteria might be relaxed for specific sector REITs. This potential tax opportunity led many property companies to announce that they would convert to REIT status. The market responded to this news with immediate improvement of the share price of those companies. However, despite much speculation and several conversions – British Land, Land Securities and Shaftesbury for example – REITs have failed to have the impact anticipated and share prices have subsequently slid.

Within the pub sector, Enterprise Inns announced that it would explore whether an internal restructuring would make it eligible to convert to a REIT after Her Majesty’s Revenue and Customs stated that it did not qualify in its present form. It is conceivable that Punch Taverns could do the same thing, possibly giving both parties the opportunity to take advantage of the Opco/Propco model.

Whether through REITs, Sale and Leaseback or Opco/Propco, there are certainly opportunities to unlock property values. A classic model is the attribution of a proportion of profits to rents and then adopting a sale and leaseback model based on that rent. Because property yields have been very low over the last few years, big multiples of rent are achievable, and often the property element of the transaction will be worth more than valuing the entire operating business on a freehold, going concern basis.

It is vital to bear in mind that as the property market has become more sophisticated; no longer are the terms of a property deal fixed. Investors understand that operators need flexibility and such property deals are becoming ever more imaginative.

New financial climate

Following the credit crunch, property yields have risen, and therefore multiples have fallen. However, in the current climate, debt is much easier to raise on property transactions than on operating businesses, so the opportunity for Opco/Propco and for sale and leaseback is potentially greater in the present market. In spite of this, some dismiss such transactions as selling the family silver.

There have been Opco/Propco ventures that have failed or been delayed, such as the Mitchells & Butlers joint venture with financier Robert Tchenguiz. Note that in a property market where debt-driven purchasers are no longer the most aggressive buyers, it may well be the financing and pricing – rather than the feasibility and suitability – of the deal that caused the delay; perhaps Tchenguiz is no longer the perfect partner.

Where to find opportunity

The most obvious area to consider unlocking property value is where there is an operating business that owns a combination of leasehold and freehold property. These businesses will trade at lower multiples and the freehold property will often not be fully valued. A sale and leaseback in instances where the operator has strongly performing assets that it wishes to hold for the long term can unlock significant value, even post credit crunch.

Coffer Corporate Leisure recently acted on behalf of Alchemy Partners, owner of Inventive Leisure, which operates over 50 Revolution vodka bars nationwide. Inventive owned a package of nine freeholds within the portfolio and Coffer Corporate Leisure was able to raise significant funds for the company to enable the bar operator to pay down debt without compromising the rating of the business. We have recently been involved in other sale and leaseback transactions in other asset sectors including restaurants, care homes and health and fitness; we see increasing opportunity, particularly for private equity investors, to raise money in this way.

Post credit crunch, it is much harder for a private equity investor to simply flip a business for a profit, and looking closely at property assets can help to improve returns on investments.