PROPERTY investment is all about picking the right assets and supporting them with appropriate forms of finance. While this normally involves buying buildings with money borrowed from a bank, there are more creative alternatives.
Compagnie Generale des Eaux, the French utility group, has just completed a three billion French francs (£0.38 billion sterling) sale and leaseback of a 100,000-square-metre office development at La Defense, Paris.
The deal with Philip Morris Capital Corporation, a subsidiary of the US food and tobacco group, is the largest recent commitment by an overseas investor and the first leveraged leasing deal in the French property market.
In London, the international consortium that owns Canary Wharf the large docklands office development, has completed a £100 million sale and leaseback transaction this year and is now trying to arrange a second, larger deal.
Peel Holdings, the small UK property company, is close to finalising a £200 million lease finance package for the construction of a large shopping centre near Manchester.
The principle behind all these deals is simple enough. Property owners unable to use depreciation and other tax allowances - usually because they do not have sufficient taxable profits - sell buildings to an organisation looking to shelter profits against tax.
The building is then leased back, with the original owner paying rent rather than interest payments on a loan. The overall cost of funds is less than an ordinary bank loan because tax allowances have been released.
The bigger the tax allowances, the better. Up to 15 per cent of the cost of a modern shopping centre is taken up with plant and machinery against which capital allowances can be claimed.
Buildings in assisted areas - such as Canary Wharf, which was built in a government-designated enterprise zone - often have even bigger tax allowances that can be unlocked through sale and leaseback transactions.
US suppliers of tax capacity, such as Philip Morris, have an added advantage over their European counterparts; they can claim tax depreciation on land as well as buildings.
Finance leasing techniques are commonplace in industrial equipment markets and hardly new to property. Meadowhall Shopping Centre near Sheffield, arguably the UK's most successful out-of-town retail development, was funded using finance leases in the late 1980s.
But the availability of lease finance in the UK ebbs and flows with the profitability of clearing banks, which are the main providers of tax capacity. With profits now at record levels, all UK banks have an incentive to shelter at least some of their gains. Royal Bank of Scotland and Lloyds are generally reckoned to be among the market leaders, but others are promoting finance leasing.
The CGE/Philip Morris deal is different because the provider of tax capacity is not a bank but a US corporation with French profits to shelter. Indeed, most French banks and insurance companies are nursing large property-related losses. That means conventional long-term property loans are difficult to come by.
"The French market is more receptive to leasing structures because conventional forms of finance are thin on the ground," said Barry Attarzadeh of Chesterton, the chartered surveyors which helped structure the deal.
There are several factors limiting the use of sale and leasebacks as a financial tool. Although the principle behind finance leasing is easy to grasp, the practice is often complex. Mountains of documentation and large legal fees make it uneconomic to arrange even basic finance leases for much less than £20 million.
Transatlantic leasing transactions are even more complex than their domestic counterparts. US providers of tax capacity such as Philip Morris are also choosy about who they will deal with.
The market is available only to borrowers, such as CGE, which have an investment-grade credit rating. British Aerospace is one of only a handful of UK borrowers to have secured a sale and leaseback with a US counterpart.
The complexity of finance leasing also implies a degree of inflexibility. Unwinding transactions if circumstances change - when the borrower wants to sell the underlying property, for example, or tax legislation changes - can be costly.
Moreover, the supply of tax capacity is finite. Banks are careful to shelter only a fraction of their total profits against tax, for fear of provoking the tax man.
Finance leasing is, after all, an elegant and established form of tax avoidance. For long-term owners of larger properties, though, lease financing provides a useful alternative to loans from banks or insurance companies.
Until the tax authorities say otherwise, it will remain so.
