Property owners and economists have watched vacancy rates rise and fall across the country since remote work and social distancing began. As lenders watching for weakness in commercial real estate, banks and credit unions — often landlords themselves — are keenly aware of the developing risks.
Branch sizes, and real estate usage generally, just aren’t the same as before 2020. A 10,000-square-foot branch with offices above street level may have made sense then. Now, at its current size, it may be too expensive, even when it still serves as a high-value location for customers or members who are inquiring about new products or closing on commercial loans.
Instead of succumbing to a lose-lose set of options, BMO Financial formulated a better strategy: sell the branch building to a real estate management company and then lease back a portion for a smaller branch.
BMO’s approach succeeded with the help of Brookline Branch Services, a real estate management company based in Syracuse, N.Y., specializing in these sale-and-partial-leaseback transactions for financial institutions. BMO reduced costs by making the brick-and-mortar footprint more efficient — without the disruption of relocation — and it even created new capital for the institution to deploy elsewhere.
BMO Makes Sales-Leasebacks Part of Branch Strategy
Chicago, Ill.-based BMO began its strategy several years ago. At the time, the bank was consolidating and relocating branches; it wanted to avoid selling an empty building as that could result in a getting a lower price.
“There’s always a situation where, if you’re consolidating or even relocating, there’s potential loss of customer deposits due to those relocations, or potential loss on the sale of an empty branch,” says Dan Cooke, former vice president of corporate real estate at BMO. “You’re looking at good locations in high-performance, high-potential markets. We want to make sure that we keep our customers and clients happy. If it’s in the right location, we’ll do everything possible to make that happen.”
In 2016, the $263.3 billion-asset bank did an analysis and determined that the book value of the branch locations was about $450 million more than the anticipated sale prices if the properties were vacant.
In addition to downsizing the locations and reducing operational costs, BMO saw increased deposits at the sale-and-partial-leaseback locations.
“Anytime we did a renovation, we want to see somewhere between a 5 to 10% increase in deposits over the next three or four years,” says Cooke. “In the branches where we did the sale and partial leaseback, they all exceeded those measures.”
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Co-Tenancy: Concerns and Opportunities
Banks and credit unions may be understandably hesitant about sharing physical space with other businesses. They need to consider security and building access and the space within the bank’s control versus the other tenants.
But financial institutions have also looked forward to the additional traffic that could be generated from a co-tenant, such as a coffee shop or co-working space. Many banks have co-tenants, such as law firms, insurance companies, title companies, and even local organizations and nonprofits, that serve mutual customers.
BMO attributes some new accounts to additional visibility and traffic from sale-leaseback tenants.
“We also saw some synergies with those co-tenants,” says Cooke. “We’ve seen an increase in business banking with the co-tenants that have gone into our sale-partial-leaseback locations.”
“We’ve seen an increase in business banking with the co-tenants that have gone into our leased-back locations.”
— Dan Cooke, BMO
Cooke advises financial institutions to consider the physical attributes of the location when assessing sale-leaseback opportunities. Parking ratios, for one, can be a point of contention if there isn’t a negotiation process between tenants. Drive-thru access can also be an issue for co-tenants. “Drive-throughs are still important to the retail network, so you have to make sure when setting this up that the physical factors and barriers are considered.”
Capital Gains Providing More Capital
Assuming the institution achieves a gain on the transaction, raising capital through a sale is another benefit of BMO’s approach.
“It’s a means to an end; banks would rather have the financial flexibility of a lease versus the risk of ownership.”
— Bill Yeomans, Brookline Branch Services
Changes to accounting standards published by the Financial Accounting Standards Board (FASB) have also made leaseback transactions more favorable. Under the old standards, institutions could not immediately recognize capital gains for a sale-leaseback transaction. But under the new FASB rules, which went into effect in December 2019, there is no requirement to defer recognition of the resulting gain. Seller-lessees can recognize the sale price when the buyer-lessor takes control of the asset.
Brookline published a real-world example of creating capital with leaseback transactions and the potential annual return on the institution’s balance sheet.
“[Financial institutions] are monetizing a physical asset they own and converting this asset into capital,” explains Bill Yeomans, founder and chief executive of Brookline. “They’re beginning to look at real estate a lot like other retailers look at it. It’s a means to an end; banks would rather have the financial flexibility of a lease versus the risk of ownership.”
Brookline looks at the branch’s size, landmass, deposit trends and market share, and various real estate parameters to determine which branches are “a keeper” and which are not. The data is then shared back with the institution. Yeomans points out that retail, operational, and accounting considerations must be in sync for a bank or credit union to consider a leaseback transaction.
“We work closely with the bank to ensure our goals are aligned,” he says.
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Banks and credit unions also use capital from leaseback transactions to make bankwide or branch-specific improvements, such as technology investments in cybersecurity or installing new ITMs or kiosks in redesigned (smaller) branches.
For BMO, “it was all about customer experience, and we had big programs in place to improve,” Cooke says. “We developed new design standards to improve the customer experience.”
Cooke recommends any institution rethinking their real estate holdings to research leaseback transactions. “It mitigated concerns about having to sell empty branches,” he says. “The sale and partial-leaseback transactions allowed us to choose a suitable size footprint for the future while generating the capital to invest in creating more branch activity and a better customer experience.”