In the current market, characterised by low interest rates and reluctance to sell property, the prospect of an asset swap may have higher appeal.
“In years gone by, asking ‘will they look at a swap?’ was a great way to end a conversation,” says JLL’s Aaron Bates, Head of Industrial – Queensland. “A swap has long been deemed too hard, too time consuming and unlikely to benefit both parties. But that was when assets were actually available for sale, and cash was king.”
“Now, the swap is being viewed as the only way to fundamentally alter the metrics of individual investment portfolios without selling assets.”
Bates says owners are increasingly willing to consider a swap, for various reasons. Some are chasing higher returns while climbing the risk ladder, others need to extend their weighted average lease expiry profile by acquiring assets with longer leases. Others are looking to add geographic diversity to a portfolio, divest obsolete assets or those with future leasing or development risk, or even acquire properties with future rezoning or development potential.
“It’s all about realigning an investment portfolio to suit their requirements at the time,” Bates says.
“The key in all scenarios, however, is the desire to keep their capital deployed, rather than selling an asset and hoping they’ll be able to reinvest the proceeds reasonably quickly.”
“In an environment with limited on-market availability, the prospect of a swap gives both sides certainty that capital will remain deployed, and their core fund objectives are met.”
Bates says there are advantages and disadvantages for both parties in a swap deal. A swap has the potential to give each party access to assets which suit their individual mandates, and also allows them to divest properties which no longer suit their fund requirements.
However, swaps also amplify concerns surrounding probity and fair market pricing – an important consideration for managers of external investor capital. In addition, it can be extremely difficult to find the ‘perfect fit’ for both parties.
“The utopia of two parties finding assets which perfectly match their mandates, and are prepared to swap, is rare,” Bates says. “So, while the drivers for a swap deal are numerous, the matches are few because the level of complexity surrounding a swap transaction is high.”
“Issues surrounding fair market value, cross-sector transactions, investor support, probity and reporting are all amplified in a swap scenario. However, none of these issues are insurmountable.”
Overcoming the obstacles
Bates maintains that, if the assets to be swapped suit both parties, most of the major barriers to a deal can be overcome.
“Arriving at fair market value is one of the more common obstacles we see arise in a swap deal,” he says, “because when both sides seek to maximise their sale proceeds, the deal may ultimately become more expensive and less feasible.”
“Furthermore, if one or more of the parties is a syndicate, the investors in that fund must be assured that they achieve the best possible return on their capital, particularly if they aren’t being provided with an opportunity to invest in the buy-side of the swap deal. Thus, probity is an important issue to address.”
“Approval processes for individual buyers and sellers also vary greatly, so it is important to understand the other party’s processes.”
“Communication and research are important factors early in the negotiation and, if conducted thoroughly, can make a deal transition more smoothly.”
For all the additional work required to successfully negotiate a swap, they make sense in today’s market where capital needs to be redeployed into assets other than low-yielding cash.
“In a market as tight as the one we’re in, the decision to sell and then buy provides a lot of uncertainty. There are very few on-market opportunities, and it can take a significant period of time and effort to redeploy capital after a sale,” Bates says. “If the market tightens during that period, and pricing moves up, opportunities are lost by the delay in deploying capital.”
“Swapping provides an opportunity to keep investor capital deployed, whilst at the same time making adjustments which benefit the investment portfolio as a whole.”
“It will be interesting to watch the Australian industrial sector over the coming months. Several swap proposals are currently in the market, and some are starting to gain traction.”
“Not every deal will come off, but those that do will give both participants an opportunity to improve their overall portfolio performance without taking investment capital out of the market.”