The timeless power of a sale-leaseback

I’ve written about casino-oriented real estate investment trust (REIT) VICI Properties (VICI) many times since its February 2018 debut. And as anyone who’s read those articles knows, I like the company quite a bit.

Its sale-leaseback setup means it purchases properties, then signs their previous owners on as tenants through triple-net arrangements. As such, the lessee pays for all property taxes, maintenance fees, and utilities alongside rent.

Typically, tenants that sign on those dotted lines are big-name companies with well-established operations… which is why none of VICI’s missed a single monthly payment during even the worst of the 2020 shutdowns.

Even so, the REIT has been a hot topic lately for less-flattering reasons. As I wrote in May:

And since Caesars has experienced slowing foot traffic since October, VICI’s stock has suffered alongside it.

As I covered on June 1, Caesars is now being bought out by Fertitta Entertainment, sparking further controversy for its landlord. Shareholders want to know if VICI can survive its largest tenant being taken private.

Meanwhile, other people (including this gentleman) are suggesting that Caesars is only suffering because of its rental agreement. Their attacks on the sale-leaseback model are emotionally compelling, but ignorant of what this kind of contract really entails…

And how valuable it can be.

There’s nothing new about the sale-leaseback model that businesses utilize on both ends of the rental agreement.

Realty Income (O), with its $58.49 billion market cap, is probably the biggest and best example of how well landlords can do under this kind of contract. And, though smaller, Agree Realty (ADC), Essential Properties Realty Trust (EPRT), NNN REIT (NNN), and FrontView REIT (FVR) all make it work as well.

Their collection of tenants, meanwhile, include Walgreens, 7-Eleven, Dollar General, Walmart, TJX Companies, Home Depot, Wawa, and Dave & Buster’s. While each of these companies have seen their individual struggles over the decades, they’re overall pretty darn successful.

Moreover, they keep signing on for more sale-leaseback or otherwise triple-net-lease arrangements, not less.

If these contracts were so destructive, sophisticated corporations would have stopped using them centuries ago – even millennia. Because that’s how far back the concept goes.

While historians can’t precisely identify the first recorded sale-leaseback transaction, they do know that ancient Mesopotamia, Greece, and Rome all had sophisticated property systems. These civilizations might have given some of their subsequent deals different names, but the economic principle would have been there regardless.

On the rental end, unlock capital by selling a property for quick cash while maintaining access to it. As for the landlords, they get to buy buildings and sign tenants in the same transaction. No “for lease” signs necessary.

More than 2,000 years later, William Polk Carey helped “pioneer’ the same concept here in the U.S.

It seems he got the idea in 1948 as a freshman at Princeton University, where he realized how envious his fellow dormers were of the mini refrigerator he had in his room. So he purchased a bunch more to lease out for small fees that added up to more than $10,000 by the end of his second year.

Twenty-four years later, he founded the highly successful net-lease REIT W.P. Carey (WPC) based on that same concept.

So did Caesars make a mistake in its sale-leaseback association?

Frankly, it’s a silly question considering the very successful examples I’ve already listed… and the fact that it was Caesars itself that created VICI for the very purpose of serving as its landlord.

I detailed its reasonings back in February, including how:

As is so often the case – though usually not under bankruptcy pressure – the casino operator wanted immediate access to capital. And that’s precisely what it got, extracting the entire value from its real estate equity in order to put that money into higher-return opportunities.

It’s also important to note how soon-to-be-owner Fertitta Entertainment doesn’t see the VICI arrangement as a deterrent. As even deal-critic Haendel St. Juste, managing director and senior REITs analyst at Mizuho Americas, noted last month, there’s nothing to suggest that “Fertitta’s offer is contingent on lease modifications.”

In which case, that company sees tremendous value opportunity in the Caesars acquisition with its standing arrangement. It’s only operational issues that Fertitta wants to change.

There’s an old saying in business: Don’t blame the hammer when someone builds a bad house. And it seems extremely applicable to the Caesars situation today.

A sale-leaseback is a tool – and just one out of many to make the most out of a business venture. There are plenty of other options available, complete with risks and rewards that could either pay off brilliantly… or fail intensely.

It’s up to each business to pick, choose, and wield what’s best for it.

I already mentioned Caesars’ falling physical foot traffic. But another tool it hasn’t wielded well is its online presence.

Earlier this year, Bettors Insider wrote a telling article about the Fertitta deal (then in the making), rightly pointing out how:

For all we know, Fertitta might do away with that arm altogether considering how it’s such an in-person operator, holding experiential-based retail like the Golden Nugget casino chain, the Houston Rockets NBA franchise, and dozens of restaurants. Being a privately owned company, it doesn’t need to disclose those plans.

What I am sure of, however, is that Fertitta will without a doubt extract value by consolidating operations. It will be able to do away with multiple high-paying positions as it combines all that it already does with the largely well-matched Caesars’ operations.

That’s the power of scale, yet another tool businesses can rely on.

Ultimately, I think we’ll find that Caesars does quite well under Fertitta – “even” with its current sale-leaseback situation. VICI isn’t the cause of its problems, no matter what certain people would have you believe.

It’s simply a tried-and-true, age-old setup that has worked, is working, and will continue to work for thousands of businesses throughout the millennia. Caesars included.

Happy SWAN investing!

Brad Thomas
Editor, The Wide Moat Daily

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