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Wednesday, 25th March 2015

Is a blue chip investment as blue chip as you think?


Please note: for the purpose of confidentiality the actual names of the Lessee and franchisee have been renamed in this article to the following;

Lessee: ASX 100 and franchisee; PG.  

At the moment there is a lot of demand from buyers for blue chip investments with long term leases (10 to 20 years) to strong national and international companies. In most cases investors are prepared to pay a premium price and receive a lower net yield for the secure long term cash flow which these type of investments provide.  

Prosper Group recently assisted one of their clients in purchasing a brand new standalone store in metropolitan Sydney with a new 15 year lease to an ASX Top 100 company.

During their thorough due diligence analysis, Prosper Group identified that although ASX 100 were the lessee on the lease documents there were several clauses within the lease which meant that the vendor potentially could lose the security of ASX 100, and consequently significantly reduce the value of their property.  

The two main issues identified in the lease documentation were;  

Issue 1; The tenant could not assign the lease without the landlords consent (which could not be unreasonably withheld), but the landlord may only withhold consent if the assignee does not have the financial resources or retailing skills to operate the business, and the assignee is not a respectable and solvent person. The lease further states that the assignor is released and discharged from and against all of the tenants obligations from the date of assignment.  

Prosper Group’s advice to their client was that ASX 100 at any time could assign the lease to any number of small operators.

If the lease was assigned to one of these small operators then the value of the property would be reduced due to an inferior lessee which would be seen by the market as providing a less secure income.  

Resolution; Prosper Group negotiated a new clause to be added to the lease that stated that if the lease is assigned to an assignee that is not of the same financial status as ASX 100, then ASX 100 must provide a guarantee of the assignee’s financial obligations under the assigned lease.  

Issue 2; The tenant may without the consent of the landlord assign the lease to one of their franchisee operators.  

Prosper Group’s advice to their client was that if ASX 100 did assign the lease to a PG franchisee then similar to Issue 1 this would mean that the landlord loses the cash flow security of ASX 100, and consequently this would mean a reduction in the property value.  

Resolution; Prosper Group negotiated this clause to be deleted from the lease.  

This transaction was off market and Prosper Group were dealing directly with ASX 100 who owned the property and therefore made it possible to amend the lease terms. In the majority of transactions that Prosper Group conduct on behalf of their clients there is no opportunity to amend the lease terms. In these circumstances it is best to assess all aspects of the property to understand the true potential risk if this event occurred and either attempt to negotiate some form of compensation for the potential risk, accept the risk, or terminate the transaction.  

In identifying and negotiating these issues Prosper Group gave their client the comfort that their blue chip investment was in fact blue chip.  

A detailed analysis of this purchase will be provided in a separate newsletter which will be sent out soon.