Why companies use capital recycling
Companies have many ways to fund their operations and expansions. They can borrow money from a bank or investors, sell stock, use retained earnings, or sell other assets. Each option has its benefits and drawbacks. Companies must weigh each alternative to determine the best option for their situation.
Many companies in capital-intensive industries will use recurring capital recycling as part of their funding strategy. For example, many real estate investment trusts (REITs) routinely sell older properties in less desirable markets to fund new property developments or acquisitions in faster-growing markets. This strategy enables REITs to increase their investment returns while reducing the need to sell stock and issue new debt to fund those new investments.
What are the pros and cons of capital recycling?
Capital recycling has many benefits. It allows companies to cash in on the value of an asset. It limits the need to sell stock, which dilutes existing shareholders. Asset recycling also reduces the need to issue more debt to fund a new investment. The strategy can allow a company to increase its investment returns by rotating out of a lower-return asset into a higher-return one.
However, asset recycling also has some drawbacks. Selling assets can trigger capital gains taxes. Capital recycling can also cause a near-term drag on a company's earnings between the time it sells an asset and the new investment starts generating a return. Companies also face the potential risk that the new investment won't deliver a higher return than the asset they sold.
