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.
The over-rent is a loan, so solve for its rate
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.
Four inputs and one solver. The advance is the over-rent capitalised at the same yield that converted rent into price.
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
269 against 385
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.
The comparison a credit committee makes automatically and a property committee usually does not.
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.
The base rate decides the size of the finding
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.
Three objections, and one arithmetic trap
Rent is senior to the bonds, so it deserves a tighter spread. Partly right, and the best of the objections. But the seniority attaches to the market-rent portion — the part the tenant needs the building for. The over-rent is the part a restructuring negotiates away first.
The over-rent cannot be capitalised at the deal yield. It can, and it is the only internally consistent choice. The deal yield is what converted the rent into a price. If 6.75 per cent is the wrong yield to value the over-rent, it was the wrong yield to pay it.
The buyer is not lending; he owns a building. He owns buildings with a vacant possession value of €83.2 million and he paid €179.5 million. The difference has all the properties of a loan and none of the documentation.
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.
What to do with it
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.
The workbooks behind this article
Every figure above is a live formula in the free companion files for
Sale and Leaseback. Each workbook ends with a Checks sheet
setting the printed figure beside the computed one. No account and no email address.
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