Sell to rent

High quality prime buildings and a trustworthy tenant have attracted investors in the private sector who buy the freehold of a property then rent it back to the sitting tenant. Is this a way for the public sector to realise some of its property assets and ease the bank balance?
For sale? The Treasury building in Whitehall. Photograph: Martin Argles/Guardian

The chancellor, Alistair Darling, has stared into the deep black hole that is the public bank balance and, as we discovered in April's budget, has decided that one way to start filling the hole – or at least stop enlarging it quite so quickly – is to sell off the public sector's assets, including its property.

Actually, that's not strictly true; the operational efficiency programme, which was endorsed by the budget, talks of the "rationalisation" of the public estate.

That term perhaps conjures up pictures of public sector estate managers scrambling round to pick out obsolete and inefficient 1960s and 1970s office buildings, old storage depots and disused yards, then trying to flog them off in a hurry. One problem is that such property is surplus and, by definition, unlikely to be high on the wish list of anybody in the market for real estate. Much of it is also low-value and, without redevelopment, unlikely to raise the kind of money that will make much difference to the big black hole.

A more effective alternative might be to relocate government staff into the 1960s and 1970s horrors and then sell off the decent property - but that could easily fall foul of the government's stated aim of reducing costs while simultaneously improving the standard of service delivery.

There is, however, a way of raising money from property which is enjoying a revival among building owners in the private sector.
Companies that own the buildings that they occupy are realising they have considerable capital locked up in bricks and mortar that is not contributing to their mainstream activities.

At least one firm of property consultants believes the public sector has something to learn from the corporates here.

By selling the freehold of the property to an investor and simultaneously leasing it back from their new landlord, the company can get property off their own balance sheet while remaining in occupation and using the proceeds of sale to better effect elsewhere in the business.

The main criteria for the investor purchasing the building will be a high quality "prime" building and a tenant with unimpeachable credit-and-everything-else-worthiness.

The advantage of this sale-and-leaseback process to the investor is that there is a ready-made tenant with a commitment to the building that is taken to be a good indication of security of income. Government departments and local authorities are at an advantage here too.

Public sector organisations can tick the decent-tenant box quite easily as they are unlikely to default on the rent and, while a high proportion of all public sector estates is likely to be of poor quality and unsuitable for an investor, some of it at least is prime, centrally located space.

The question for many public sector bodies will be that, although they could do with the cash now, is the middle of a recession really a good time to sell?

John Wilson, head of corporate strategies at property consultant CB Richard Ellis, believes it is. "The current financial climate may actually enhance the opportunity for governments to sell and leaseback assets," he says. "With active investors remaining highly risk-averse and with demand focused on prime property in liquid, transparent markets, public authorities are often the ideal candidate to offer long, secure income streams from quality covenants."

It compares well to other forms of fund raising available to the public sector too. "If you go out and issue a bond, at some stage you are going to have to pay it back," says Wilson.

He adds that despite the recession there are a surprising number of financial institutions such as pension funds and German open-ended funds with money waiting to be invested in property.

"For investors who fear the prospect of rising government bond yields and/or a higher level of inflation in the years ahead, a building let to the state on a long lease has attributes similar to index-linked government bond, with the benefit of owning a real asset at the end of the lease," Wilson says.

Wilson is involved in a private sector sale and leaseback of a portfolio of industrial property and has been "massively surprised" by the level of interest.

Also a surprise, perhaps, is that the supply of such assets is not great which enhances the opportunity for the public sector.

"Reduced stock in the market provides further opportunity to convert these assets at the moment," says Wilson.

While one disincentive may be the perception that the recession means the property seller might not get the best price, Wilson points out that the rent shouldn't be at peak market levels either.

The downside is of course that there is a quarterly rent bill to be paid, which may require some budgetary imagination for some public sector bodies. There may also be the perception that, at the end of the lease, the public sector tenant could find itself homeless. Wilson dismisses this, pointing out that the investor buying to lease back will only be interested in a long lease of 20 to 25 years anyway and that the normal renewal provisions in leases would enable the tenant to negotiate a lease to follow on.

Being a tenant also provides the freedom to walk away and find something newer and perhaps more suitable leaving the landlord to deal with a, by then possibly, obsolete building.

Sale and leaseback is by no means a UK phenomenon and Wilson says governments throughout Europe are looking at it as a means of reducing public borrowing.

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