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Bond Investors Worry About Government Debt And That’s Bad For CRE

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Pressure has been building over inflation expectations. When will the Federal Reserve cut interest rates? How long before CRE could return to, if not to a zero-rate policy, then closer to the pre-pandemic situation?

But another storm is on the horizon, one that some have been warning about although they’ve been largely ignored. The issue is the level of government debt, which is up to almost $34.6 trillion according to the non-partisan nonprofit Peter G. Peterson Foundation. The reason is structural factors, such as a large aging segment of the population, rising healthcare costs, and government spending that doesn’t bring in enough taxes to pay for what Congress authorizes.

Deficit spending requires more borrowing through government debt instruments as Reuters reports.

“Investors are bracing for a flood of U.S. government debt issuance that over time could dwarf an expected rally in bonds, as they see no end in sight for large fiscal deficits ahead of this year’s presidential election,” they wrote.

The mechanism that worries them is straightforward. There are three methods the U.S. government can use to obtain revenue to pay for its obligations. One is through taxes, but the amount brought in isn’t close to what is needed. The second is by printing money, which would eventually generate inflation. Third is borrowing, the approach the U.S. has used for generations.

Borrowing dynamics follow basic economics keeping one dynamic in mind — bond prices and bond yields move inversely. The more demand there is from those who want to lend the U.S. money by buying bonds, the lower the yield the government has to offer. The more debt the government wants to sell — that is, the more supply— the higher yields need to be to attract buyers. Also, the more the U.S. presents as a risky borrower, the greater the yield lenders/buyers will demand, and the more the government has to borrow, the riskier it seems.

Benchmark 10-year Treasury yields, now at around 4.4%, could go up to 8%-10% over the next several years, Ella Hoxha, head of fixed income at Newton Investment Management, who favors short-term maturities in Treasurys, told Reuters. “Longer term, it’s not sustainable.”

Meanwhile in some quarters concerns are reaching nightmare proportions. Jeffrey Gundlach, the CEO of investment management company DoubleLine Capital, is afraid the growing debt burden of the US government could eventually lead to a restructuring of US government debt, which would be unprecedented.

The world would likely see debt restructuring as an admission of problems and greater risk, increasing yields even more.

The bottom line for CRE: higher yields on the 10-year and SOFR — and both are strongly correlated and baselines of loan rates — would force real estate borrowing rates up.

 

Source:  GlobeSt.

 

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How Sale-Leasebacks Help PE Raise Capital In A Tight Market

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Funding for growth, refinancing corporate debt, and merger and acquisition activities are top priorities for many private equity firms. A recent PwC report noted that 60% of CEOs plan to make at least one acquisition in the next three years. The report further explains that lower levels of M&A activity during 2023 created “pent-up buyer demand” moving into the current year. However, tapping into capital isn’t always easy when it is locked in assets.

“It’s quite inefficient for private equity firms to have capital tied up in real estate assets that aren’t earning for them,” says Tyler Swann, managing director, investments at W. P. Carey. “An alternative is doing a sale-leaseback, which provides a much lower cost of accessing capital than traditional financing methods.”

Understanding sale-leasebacks and their advantages can help private equity firms strategically manage growth funding, debt maturities and other capital needs.

 

The Advantages of Sale-Leasebacks

With traditional financing strategies such as mortgages, terms are often shorter and exposed to higher market volatility. Accessing capital can also be time-consuming, a challenge for firms that need to move quickly for acquisition deals. That’s not the case with sale-leasebacks, notes Swann.

“Sale-leasebacks are very flexible,” says Swann. “The processing time can be as short as 30 to 45 days between the initial call and the actual funding. It’s not unusual for us to get a call from a private equity firm saying, ‘We’re closing on a business in 30 days; can you be there to close with us as acquisition financing?’ And that’s something we can do.”

He explains that capital uses also have very few restrictions, with the most common purposes being acquisition financing, dividend payments, and refinancing maturing debt.

 

Misconceptions About Sale-Leasebacks

As private equity firms consider sale-leasebacks, questions often linger regarding who qualifies for this type of financing. Many believe that because their real estate is in a secondary or tertiary market, or their asset doesn’t have a huge value, they won’t qualify. But according to Swann, that’s not necessarily true.

“If you have a specialized manufacturing facility in a small market, you may think it won’t qualify because it’s not a high-quality warehouse in a market like Southern California,” says Swann. “Despite where an asset is located, if it’s profitable and contributing to the bottom line of a business, it could be a great candidate for a sale-leaseback.”

As the market progresses through 2024, Swann expects sale-leaseback activity to continue upward, partly due to M&A activity and its flexibility to tap into capital quickly.

“Every year, sale-leasebacks become a little more accepted in the private equity community as a source of financing,” says W. P. Carey’s Swann. “Ten or 20 years ago, corporate debt was by far the dominant option, but we continue to see an increase in sale-leaseback deals every year.”

 

Source:  GlobeSt.

 

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Sale-Leaseback Is Quickest Path to Debt Restructuring, Panel Says

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Sale-leaseback deals are offering property owners a stable, long-term solution to restructuring their debt when the lending window for refinancing mortgages has been slammed shut.

Increasingly, sellers are flocking to long-term net lease deals as the first step to cure their balance sheets, using the proceeds from the sale-leaseback to jump-start their debt restructuring, according to a panel of experts at the GlobeSt. Net Lease Spring 2023 conference in NYC this week.

“Sale-leasebacks are uniquely positioned to recapitalize existing mortgage yields,” said Bryan Huber, director of SAB Capital’s Sale-Leaseback Group.

For companies that still want to do deals but find the current cost of debt prohibitive, sale-leasebacks offer a less expensive, alternative form of borrowing that can close faster, the experts said. Sale-leasebacks deals also don’t require back-end balloon payments that often come with traditional financing.

Ross Prindle, global head of Kroll’s Real Estate Advisory Group, said buyers are using their resources, including financing and cash deals, to make sale-leaseback transactions more attractive to sellers by making it less expensive to execute the deals.

“The winners will be [the buyers] who do the best underwriting,” Prindle said.

 

“Eight is the new six in cap rates,” said David Grazioli, president of US Realty Advisors. “The cost to capitalize these rates is making a 20-year deal with 3% bumps look a lot better.”

According to Grazioli, an increasing number of sellers are opting for sale-leaseback deals because they have an urgent need to rehabilitate their cash flow and can’t wait for cap rates to compress again.

However, several experts on our panel warned that buyers must take care to make sure sellers actually are creditworthy before they ink sale-leaseback deals, which are extending to terms as long as 25 years in the current environment.

During Tuesday morning’s State of the Industry roundup session, Gary Baumann, CEO of NJ-based ARCTRUST Properties said the current credit climate is creating opportunities for sale-leaseback transactions.

“Where the credit climate is creating an advantage for all of us now is that it’s opening the window for the sale-leaseback market, larger than it’s been for a long time,” Baumann said. “Because of what’s happening with the banks, we’re seeing opportunities to acquire net leases that weren’t there before.”

On the opening night of our annual Spring Net Lease conference, W. P. Carey announced the largest sale-leaseback transaction in the NYC-based company’s 50-year history, a $468M sale-leaseback of a portfolio of four pharmaceutical R&D and manufacturing campuses in the Greater Toronto Area (GTA).

The portfolio represents the lion’s share of the global operations of Apotex Pharmaceutical Holdings, the largest generic drug manufacturer in Canada.

“This deal would have been a lot tougher to do when there were $200m to $300M CMBS deals available that could close simultaneously,” Gino Sabatini, head of investments at W.P. Carey, said during our sale-leaseback panel discussion.

According to Zachary Pasanen, managing director, investments at W. P. Carey, sellers are flocking to sale-leaseback for a less-expensive cost of capital and extra liquidity during tough times. A sale-leaseback offers a “naturally accretive” alternative funding source, Pasanen told GlobeSt. last month.

Holders of fungible, mission-critical real estate that are willing to sign a long-term lease with market or better rental increases built in can establish an underlying rate that lets them monetize those assets and is inside the going long-term borrowing rate, Pasanen said.

 

Source:  GlobeSt.

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