From CFO
Take time to review your financing arrangements but be prepared to pay for peace of mind.
With interest rate hikes on the horizon, together with economic
uncertainty, companies should review their property finance. Keith
Rodwell, the managing director of GE Commercial Finance, says: “I think
that one of the things that you’ve seen recently is a number of the
banks talking about preparing for rising interest rates, preparing for
potential tougher economic times, and I think that it highlights the
need for customers generally to be thinking about the future.”
He says they should think not only about their current financial requirements but what they might need in the future.
Chief financial officers should be looking to match their assets to facilities, says Rodwell. Most company property assets are financed by five-year revolving credit facilities twhat are reviewed annually, the reason being that bank regulations require less equity input for money lent for less than one year. This makes the facilities lower risk – with the risk passed to the customer – and they can be priced more cheaply. Typically, these facilities will lend about 50% of a property’s value.
Rodwell says: “If you look at credit cycles, those facilities get pulled back or passed for amortisation or debt repayment, and that sort of request often comes at the worst possible time … You can find yourself doing nothing wrong, paying your bills, paying your repayments and, through no fault of your own, there is a requirement to reduce the overall facility. That additional repayment can cause severe cashflow problems for companies, and we see that quite a lot.”
Banks, being in the business of managing risk, are quick to pull back credit when dark clouds appear on the economic horizon or when a particular industry falls out of favor.
One option is to go to a non-bank lender, such as GE or Orix, for longer-term finance. GE, for example, offers facilities of five- to 10-year terms, lending up to 85% of asset value. The trade-off is that the cost of capital is 50 to 100 basis points higher than those provided on revolving facilities from banks.
Rodwell says: “If the customer is paying us back we can’t ask them to pay any more back. We are committed to the term. That commitment means that the risk is being transferred from the customer to us.”
At the smaller end of business, a lot of lending is backed by personal assets, mostly homes. Typically, facilities may also be linked into personal superannuation schemes. This would involve buying an industrial asset as an individual, securitising it and gradually selling chunks of the property to a personal superfund as it has the cash available.
Ray Gent, the national director business and industrial space at Knight Frank, warns that the small end of the industrial property market is sensitive to interest rates, which could cause problems for buyers. He says business owners will buy rather than lease, as they can borrow at below 8%, compared with yields of 8% (in some cases, more) on industrial properties. Recent low interest rates have been driving this small end of the industrial market. Gent warns that a market imbalance may be coming as interest rates step up, in that any company trying to sell its assets will not get back what it paid.
Larger industrial assets are sensitive to the lease covenant – which, in turn, depends on the credit strength of a tenant – rather than interest rates. And when looking at taking property off balance sheet, the right lease structure is critical to a deal’s success. There are three main options, depending on the size of the deal: to inject property into an existing industrial trust, create an unlisted vehicle and to create a listed property trust.
Matthew Lawrence, an associate director in Westpac Banking Corp’s specialised capital group, says: “Corporate tenants are demanding more than simply a competitive deal. They want a comprehensive approach, to ensure that the value they bring to the table is properly recognised and rewarded. Increasingly, CFOs are able to obtain better value and better property solutions through more sophisticated transactions.”
In 2003, Lawrence’s team was working on the creation of the unlisted FAL Property Trust, a vehicle to enable Foodland Associated Limited (FAL) to take $183 million of its retail and industrial assets off balance sheet (see page 44).
The unlisted route was taken by FAL because the property portfolio was not large enough in value to list. Although unlisted securities do not have the liquidity of their listed counterparts, they are less volatile. They can also be geared more highly – up to 60%, compared with 35Ã40% with listed vehicles.
Thanks to higher gearing, unlisted trusts have better tax advantages for investors. In FAL’s case they receive 100% of tax deductions for the first three years, possibly up to five, according to Lawrence.
He adds that the off-balance-sheet route is viable for most industrial properties: “There’s no reason why you can’t do things with industrial similar to what can be done with office. It’s just the size and the value of it all. The larger and more expensive the property is, the more options and more sophisticated you can get … A lot of corporates tend to think they [industrial buildings] are more specialised than they really are.