Pot Farmers Depart as Companies Hire Lease-Breaking Firms

Legacy Portfolio, a U.K. company that takes over leases for unwanted offices and warehouses, sometimes gets more than it bargained for.

Last year, Legacy discovered that a south London depot was being used to grow marijuana. A month later, the building was hosting “rave” parties, prompting the company to hire former soldiers as security guards. Legacy found another warehouse, near Manchester, that collapsed after thieves stole the metal frame for scrap.

Both properties were formerly occupied by Wolseley Plc (WOS), the world’s largest plumbing and heating products supplier, which had transferred them to Legacy to help cut 77 million pounds ($124 million) of costs for 177 properties it no longer needed. The U.K.’s 100 largest publicly traded companies have unused buildings that will cost them about 1 billion pounds by the time the leases expire, Cushman & Wakefield Inc. estimates.

“Wolseley provided the kick-start to the market,” said Paul Vernham, head of corporate real-estate consulting at DTZ Group Plc. “Lease liability outsourcing will be an accepted practice, like sale and leasebacks, by the end of the decade for the private and public sector.”

Legacy terminated 120 leases after settling with the landlords and found tenants at other properties to replace Wolseley. By last month, the 47 million pounds Legacy received from Wolseley was enough to cover any remaining liabilities.

Upfront Fee

Rather than acquiring leases, outsourcing companies take on liabilities from the leaseholder and try to reduce them as quickly and as cheaply as possible. Unlike brokers, they receive an upfront fee which covers only part of the total liability costs. The companies keep whatever is left over once they have dealt with the surplus leases.

So far, only a handful of companies have outsourced their surplus rental properties. The prospect of a second recession in three years, however, combined with proposed accounting rules that would force companies to report all lease liabilities, may encourage more to emulate Wolseley.

“Corporate U.K. has come through the recession by right- sizing their portfolios,” generating in some cases hundreds of properties they no longer need, said Matthew Stone, a partner at Cushman. The U.S. property broker advised Wolseley on the lease liability deal.

Legacy is raising a $100 million fund in the U.S., which would allow it to provide guarantees for as much as $1 billion of lease-liability transfers. It also plans to raise a fund for the U.K. In both cases, investors can expect annual returns of more than 25 percent, Legacy Chairman Alexander Anton said.

Surplus Sites

Since Cushman worked with Wolseley, the broker has held talks with 35 of Britain’s 250 largest publicly traded companies about their surplus sites, Stone said. He declined to identify the companies.

While the U.K. economy grew faster than economists forecast in the third quarter, site closures and job cuts have lifted Britain’s unemployment rate to a 15-year high. Europe’s sovereign-debt crisis and a U.S. recovery that Federal Reserve Chairman Ben S. Bernanke calls “frustratingly slow” are weighing on the global economy, at a time when the British government is implementing the largest budget squeeze since World War II.

Store Closures

Retailers are one of the biggest contributors to the rising number of surplus properties. HMV Group Plc (HMV), JJB Sports Plc (JJB), Carpetright Plc (CPR), Thorntons Plc (THT) and Mothercare Plc (MTC) announced plans this year to close more than 300 stores in total across the U.K.

Annual rents amount to about 153 million pounds for all those outlets in the U.K. occupied by the five companies and the average lease length is more than nine years, Investment Property Databank Ltd. estimates. That implies a total of almost 1.4 billion pounds before costs such as insurance, security, repairs, maintenance and property taxes.

“There’s a glut of empty space -- it doesn’t matter if you’re talking about sheds, shops, offices or hotels,” said Robin Priest, chairman of Property Alliance Group Ltd. The Manchester-based company is bidding for some of the outsourcing contracts.

Alternative Tenants

While some abandoned and unused buildings became prey for opportunists for illegal activities, Legacy’s work in ending leases and finding alternate tenants ultimately saved Wolseley about 30 million pounds.

Wolseley was planning to tackle itself the costs for the 163 surplus buildings that the company leased and the 14 it owned. The outsourcing deal was a better way to free up staff to focus on the property needs of continuing businesses, said Andrew Pickett, the U.K. real estate director at the Zug, Switzerland-based company.

As the economy deteriorates, outsourcing companies may struggle to find new tenants or settle with landlords to break leases. They have to refurbish properties or work with property owners to find alternative uses for buildings, which require expenditure and time.

“That’s where the real skills come into play,” said Adam Foster, managing director of Surplus Property Solutions, or SPS, which took over 89 surplus leases and six properties in August 2006 from Rentokil Initial Plc. (RTO)

SPS lined up a new tenant to sub-lease a 100,000 square- foot warehouse in Scotland from Rentokil before converting the building into a biomass-processing plant. SPS then got a replacement tenant in, cutting Rentokil’s liability to 1 million pounds from 3 million pounds.

To make surplus lease transfers less risky, deals may need to include properties for sale or sale and lease backs, the outsourcing companies said.

Otherwise, “you are betting that you can beat the market,” said Ian Ellis, executive chairman of Telereal- Trillium, a unit of closely held William Pears Group of Cos. “There’s not a lot of value against a lot of downside if you get it wrong.”

To contact the reporter on this story: Simon Packard in London at packard@bloomberg.net.

To contact the editor responsible for this story: Andrew Blackman at ablackman@bloomberg.net.

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