Perseverance pays off

Conrad Bernard, SIOR, and Mike Boyd, CRE, SIOR, win TAR’s William C. Jennings Award for commercial transaction of the year.

The winners of TAR’s 2000 William C. Jennings Lone Star Award had done sale-leasebacks before, but never one of this magnitude.

In late 1999, Conrad Bernard, a broker with Boyd, Page & Associates in Houston, was approached by a client, Baker Hughes Inc., looking for ways to improve its balance sheet. Bernard and Mike Boyd, a principal in the firm, felt that since Baker Hughes owned a significant amount of real estate, one way to accomplish their goal would be through a sale-leaseback on one or more facilities.

A sale-leaseback offered several advantages. Not only would the sale provide cash to retire debt, it would reduce the amount of Baker Hughes’ real estate assets, thereby reducing their annual depreciation charge. In addition, a sales price in excess of their tax basis would generate a capital gain, which would improve earnings per share. Since Baker Hughes is a publicly owned Fortune 500 company, all these possibilities appealed to them.

Laying the groundwork

Bernard and Boyd helped identify four assets as possible candidates for disposition. They then evaluated the properties to determine market value and to structure proposed lease terms that would generate the optimal value when capitalized. The client set one firm parameter: They would not sign a lease with a term in excess of 15 years because of their concerns over the definitions set forth in Financial Accounting Standards Board interpretation 13. A lease of more than 15 years could be construed as a capital lease thus defeating one of the goals. Other than that, Baker Hughes was flexible on the terms and conditions.

The properties selected contained 1,061,471 square feet of improvements located on four sites totaling 79.5 acres. The buildings included an office complex, a manufacturing plant, a research lab, and a training facility.

Using an income approach, Bernard and Boyd estimated a total value of $117,600,000, or just over $110.78 per square foot. Based on the quality of the assets and the credit of the tenant (A-), they felt that a cap rate in the 8%-8.5% range might be achievable. An 8.5% return equated to an initial net annual rental of $9,996,000.

Teaming up and getting the word out

"We had marketed a lot of investment properties over the years," says Boyd, "but we had never taken on a project of this size and complexity." Boyd, Page & Associates was competing for the listing assignment with another firm, Arroyo & Coates, based in California. Arroyo and Coates specializes in investment property sales and had prior experience with the client. "After checking out their rather formidable credentials, we considered proposing a co-marketing arrangement with them," says Boyd. Boyd and Bernard felt they could offer the client local market expertise, and Arroyo and Coates could bring their numerous investor contacts to the equation. "Before we were able to contact them, they called us and proposed a similar arrangement," says Bernard. The client approved, and the two brokerages started putting together a marketing plan.

Between the two firms, they assembled a list of more than 700 prospects. These potential buyers included pension-fund advisers, large institutional investors, syndicators, and 1031 buyers. "Since we had a relatively short marketing time, we used every means we could to contact prospects–mail, e-mail, fax, and phone," says Bernard. "We put together both a printed, bound package and an electronic package that could be e-mailed."

Since confidentiality agreements were required, the brokers set up their e-mail so interested parties could respond utilizing a code in the message of their e-mail that would trigger an automatic response e-mail with an attached confidentiality agreement. The prospect could then print out the agreement, sign it, and fax it back.

Once the confidentiality agreement was signed, prospects would receive the total package, which consisted of separate write-ups on each of the properties. "By using e-mail, we were able to immediately send packages to everyone requesting them at virtually no cost," Boyd says. "This made it possible for us to expose the property to a wide audience in a short period of time."

"We utilized our network, CORFAC International (Corporate Facility Advisors), to distribute the information to overseas investors and the SIOR network to cover the domestic markets," adds Bernard. In all, they sent bound or electronic packages to more than 150 interested parties.

Zeroing in on a buyer

The presentation the brokers sent to prospects did not include an asking price, but it did set forth proposed lease terms and conditions and solicited proposals from interested parties. The price was to be cash with a closing by Aug. 15, 2000. All proposals were due by June 15. "We reserved the right to reject all offers or accept a proposal prior to the deadline," says Boyd.

Within two weeks, serious inquiries started pouring in. Most prospects wanted a price that would yield an initial return of 9% or more, and many wanted a lease term of 20 years or longer. "We were pleased with the number of responses, but we were falling short of our targets for price and lease term," says Boyd. "With the Fed raising interest rates, we were beginning to wonder if we had set our sights too high."

One day, though, Bernard noticed a news release on the Internet about an institutional investor not on the target list that had purchased a large portfolio of properties. "We contacted them and generated immediate interest," Bernard says. "Within a week, they came to town, made an offer, and struck a tentative deal–subject to inspection of the properties and approval of their board." The investor was a large, tax-motivated, credit company that planned to leverage the properties up to 90% to 95% of the total value. They planned to achieve this by converting the lease from a "net" lease to a "bond" lease and obtaining residual value insurance to assure the lender of payment of the loan balance at the end of the 15-year lease term.

"Rather than accepting our rent stream, they proposed one that yielded Baker Hughes a higher sales price at a lower initial rental number than we had proposed," says Boyd. "Because of the debt structure, tax motivation, and a staggered rent stream, the buyer effectively was doing a zero cash-flow deal. Also, we negotiated the right for the client to substitute properties should their operations change during the lease term."

It’s always something

The parties proceeded toward a June 30 closing. "Less than a week before closing, we were told that the board of directors had not approved the purchase of the total portfolio, but would approve purchasing 50% of the properties if a partner could be found for the other 50%," says Bernard.

Everyone scrambled to find a partner or another buyer. It took another month, but through the combined efforts of the original buyer, the mortgage broker, and the real estate brokers, another credit company buyer made an offer to acquire the deal on the same basis–if they could take the entire package. The original buyer agreed to assign their contract–for a reasonable fee.

"On Sept. 25, 2000, we closed the sale at a price of $119,300,000, exceeding our projected target price, and doing so on a rental stream which was less than we anticipated," says Boyd. "Even though we teamed with outside investment specialists, it was Conrad Bernard’s diligence in pursuing every possibility–including that Internet news release–that led to the buyer."

"As with any transaction of this complexity, there were numerous hurdles to overcome throughout the process," says Bernard, "but the ultimate satisfaction was in exceeding the client’s expectations."

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