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. Last Updated: 07/27/2016

Ericsson to Sell and Lease Back Office

MTEricsson hopes to get more than $28 million for the title to its Moscow office building.
Swedish telecommunications giant Ericsson intends to sell its office building in northern Moscow for more than $28 million and then lease it back.

It is the first so-called leaseback offer in Russia and is being seen as a new stage in the development of the country's real estate market.

By selling its real estate, Ericsson would free up capital to use in its core business. But it also intends to retain the use of the property through a binding lease.

The offer is for five-story, class A office building located at 12 Ulitsa Vosmogo Marta that was built in 1998 by Finnish construction company SRV Terasbetoni Oy.

Ericsson plans to commit itself to a 10-year lease on the entire building, or roughly 9,000 square meters.

"Investors are not looking at the building because they like the bricks," said Jack Kelleher, managing director of Noble Gibbons, the local affiliate of CB Richard Ellis. "They will buy because they are attracted to the quality and security of cash flow."

Noble Gibbons is the investment manager for the building sale, and a deal is expected to be closed by the end of the year.

Kelleher said an investor could expect the Ericsson building to provide a 13 percent yield. However, if an investor borrowed a large part of the money for the purchase at cheap rates, it could achieve a return from the low to mid-20 percent range, he added.

The company is targeting Western investment funds, many of which have visited Russia in the last year, but which have struggled to find suitable investment packages.

Kelleher said many U.S. and European funds are not willing to take on the high risks of development and construction, which in the last decade have produced yields of more than 30 percent in Moscow. But the funds should be attracted by sale and leaseback deals.

"When you buy the asset, you buy the real property and the lease and your cash flow is relatively clear," Kelleher said. "The tenants pay for the operating expenses and cover risks such as rises in land taxes or utilities."

He said the funds are looking beyond the core office markets in Central Europe, such as Prague, Budapest and Warsaw -- all which are much smaller than Moscow.

"They are coming further east and have to look at Moscow's significantly larger market."

Kelleher said the Ericsson offer reflects the capital's transition to a more predictable market. Yields are coming down and property values are rising, he said, adding that two years ago, such a sale and leaseback transaction would have produced significantly less sales gain for the corporate owner-occupier.

Maxim Kunin, director of investment services at Noble Gibbons, said sale and leaseback is part of a global trend of corporate divestment of real estate. There was a wave of such deals made in the United States in the 1970s and 1980s, and European countries followed the trend in the subsequent decades.

The properties involved are not only offices, but also shopping centers and industrial real estate.

"Very few corporations in the United States own real estate," Kunin said.

"Ericsson has disposed of a tremendous amount of real estate in the last couple of years," he said. "Other corporations may say that now is the time to move out of real estate because the return on capital in Russia is higher."

Ericsson declined to comment on the offer. The company's fortunes have declined in the last year in line with lower sales of its mobile telephone systems.

Oleg Myshkin, head of Colliers International's office department, described the offer as brilliant.

"Potentially, it's a very good acquisition target for investment funds or equity investors," he said.

However, he said that the yield at 13 percent may not be high enough; even in the center of Moscow a 15 percent yield was the minimum to attract investors. Otherwise, investors could receive better returns in Eastern Europe, where EU-applicant countries present lower risks than Moscow.

The Ericsson building, which is just off Leningradsky Prospekt, might command an even higher yield than buildings in the center, Myshkin said.

But such high yields, which reflect rental rates, would make sale and leaseback deals unattractive to multinationals, which currently have access to very low interest rates. On the other hand, Russian companies could be attracted to such deals if their cost of capital is high, Myshkin said.

Gerald Gaige, a partner at Ernst & Young and head of its business valuation and real estate advisory services groups, agreed.

"We have been looking at sale and leaseback from the point of view of developing businesses," he said.

"Take retail business, such as the Sedmoi Kontinent or Perekryostok supermarkets, the 36.6 pharmacy chain which own their premises. They are owned by very successful operating businesses that have an excellent potential for growth, yet a lot of their capital is tied up in the real estate.

"That presents an opportunity for them to do a sale and leaseback, capture the capital and grow their real business instead of having so much tied up in a non-core asset."