The part of a sale-and-leaseback price that no building supports is a loan to the tenant, and a loan can be priced against the tenant's own paper.
No. The over-rent in this portfolio — €36.8 million advanced, repaid only out of €2.5 million a year of rent above market — carries an implied credit spread of 269 basis points. The same company’s senior unsecured bonds pay 385 basis points. The property buyer is paid 116 basis points less than the bondholder for exposure to the same obligor, over twenty years rather than five, with nothing securing the slice and no way to sell it.
Worked in full in Sale and Leaseback by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The portfolio is nine buildings let back to one European food group on a twenty-year lease with no break. The passing rent is €12.1 million. The market rent — what the same buildings would let for, today, to somebody else — is €9.6 million. The difference, €2.5 million a year, capitalised at the deal yield of 6.75 per cent, is €36.8 million of price that no building supports.
That has every feature of a loan. A principal, a coupon, a term, a single obligor, a recovery on default. What it lacks is a rate anybody has quoted. So compute one. Discount the over-rent stream at a rate, adjust the rate until the present value equals the advance, then subtract the risk-free rate. It is a bond yield calculation and it takes one line in a spreadsheet.
| Input | Value |
|---|---|
| Advance — over-rent capitalised at the deal yield | €36.8 million |
| Over-rent, year one | €2.5 million |
| Indexation within the cap | 2.2 per cent |
| Firm lease term, years | 20 |
| Nominal over-rent repaid over the term | €61.5 million |
| All-in rate that equates the two | 5.29 per cent |
| Less the twenty-year risk-free rate | 2.60 per cent |
| Implied credit spread, basis points | 269 |
The same company can issue senior unsecured bonds at 385 basis points over. That is the rate it was quoted before it chose to sell its property instead. The buyer of the property, lending to the same name through the rent, is paid 269 basis points. The gap is 116 basis points, in the bondholder’s favour, on the same signature.
| Measure | Over-rent slice | Senior unsecured bond |
|---|---|---|
| Spread over the risk-free rate, basis points | 269 | 385 |
| Term, years | 20 | 5 |
| Recovery on the whole position, per cent | 44.7 | 40 |
The two recovery lines are not the same line, and conflating them is the error this arithmetic is most often used to commit. On the over-rent slice itself, recovery is nil: the buildings back the market-rent portion of the price and are fully used up doing it, so nothing is left to secure the €36.8 million. The 44.7 per cent is recovery on the whole position — everything paid, bricks included — against 40 per cent for the bondholder. That is a real advantage and the honest case for the asset class. It is an argument about the transaction, not about the credit slice, and it cannot justify the spread on the slice.
One caveat, and it is a real one. The 269 basis points is struck over the twenty-year risk-free rate of 2.60 per cent, because the lease runs twenty years. The bond’s 385 basis points is quoted over the five-year rate, because the bond matures in five. On an upward-sloping curve those are not the same base. If the five-year rate sits 30 basis points below the twenty-year — a normal slope — the like-for-like gap narrows to 86 basis points, and at a steeper slope it reverses. Take the point on the curve that matches each instrument, and state which one was used.
The maturity point is the sharper one, and no curve adjustment softens it. A five-year spread compensates for five years of default risk. The lease runs twenty. Credit spreads are not linear in maturity, and the difference between five and twenty years of exposure to a leveraged mid-cap is not small. The buyer accepts a five-year price for a twenty-year risk, and is paid 116 basis points less than the five-year price to do it.
The trap sits in the decomposition. Run the price with two columns — bricks, and everything else called credit — and the advance becomes €96.3 million, or 53.7 per cent of the price. Against €2.5 million a year of over-rent, that cannot be repaid at any interest rate over twenty years, and the spread calculation has no solution at all. Costs avoided are worth something on every let building ever sold and are an advance to nobody. They belong outside the loan.
Run this before the yield discussion, not after. It needs two things: the rent schedule, and an independent market rent. It converts a property question into a credit question, which is the question most acquirers of this asset class are better equipped to answer. If the implied spread sits inside the tenant’s own traded debt, the price pays less than the market charges for the same name, and only recovery can defend it. On this portfolio the exchange is explicit: 116 basis points less spread, nothing securing the slice, four times the maturity, no ability to sell — against 44.7 per cent of recovery on the position as a whole. Whether that is a good exchange is a judgement. That it is the exchange being offered is not, and a yield of 6.75 per cent discloses none of it.
Capitalise the over-rent at the deal yield to size the advance: €36.8 million here. The repayment stream is the over-rent, €2.5 million in year one, indexed at 2.2 per cent over a term of 20 years. Solve for the discount rate at which its present value equals the advance: 5.29 per cent all-in, less a risk-free rate of 2.60 per cent, is 269 basis points.
On the whole position, yes: 44.7 per cent of everything the buyer paid comes back if the tenant fails, against 40 per cent for the bondholder. On the over-rent slice alone, no. Recovery there is nil, because the buildings back the market-rent portion of the price and are fully used up doing it.
On this portfolio, 36.7 per cent: a signature premium of €29.0 million plus over-rent of €36.8 million. Bricks and costs avoided are 62.3 per cent, and 1.0 per cent is irrecoverable operating cost capitalised into the price. Only the bricks, 46.3 per cent of the price, survive a tenant default.
This article is one calculation from Sale and Leaseback. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: real estate investing, finance and fund management → · All 1706 articles →
If this book helped — or didn’t — a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.