$175 Billion is a Terrible Thing to Waste

In today’s world, it’s increasingly challenging for senior management to deliver the financial results demanded by stakeholders. Businesses have been reengineered, workforces right-sized, costs contained, and processes moved offshore. Some opportunities still exist to make impact in these areas, but the low-hanging fruit has been picked. However, good news does exist: Untapped opportunity in corporate real estate portfolios represents a significant way to positively impact the balance sheet. According to a recent study, corporate America has $1.3 trillion in real estate on the books, and of that $175 billion represents excess capacity that is lying idle. CFOs are taking a new look at real estate as a way to improve financial performance because, next to payroll, it is a company’s biggest cost driver. A recent CFO survey found that 88% of the respondents identified reducing operating and occupancy costs as the major goal for corporate real estate. Many have achieved this objective by supplementing their real estate function with outside real estate advisors to maximize performance. According to the report, 75% of the companies that utilize real estate advisers report significant cost savings. In addition, 65% believe that their corporate strategy and real estate function are not well integrated, representing a key area for significant value creation. Real estate has dual roles. As a factor of production, its first priority is to provide housing for operations. As a financial asset, real estate’s bottom-line effect historically has been secondary. No matter how good a facility may be as an investment, if it’s not also an efficient factor of production, operating losses will undermine any investment gains. As companies change how they do business, they are also redefining the workplace. Companies are re-positioning themselves in the marketplace and their housing needs have been impacted dramatically. For example, a recent study conducted for CoreNet Global found that in 2010, 21% of companies plan to have their employees working remotely up to half of the time, as compared with 7% today. Companies are demanding far more flexibility and strategic fit from their real estate portfolio. While real estate is difficult to scale quickly and efficiently, it’s possible to have both control and flexibility with reasonable cost. The key lies in mapping real estate decisions to overall business strategy and utilizing the capital markets in an innovative manner to achieve the desired financial results. Companies increasingly are turning to advisers with expertise in this area. As a result, they’re finding that real estate is working for them in new ways that are creating significant value. Linking Real Estate Decisions to Business Objectives The key to realizing gain from the untapped potential of a firm’s real estate portfolio is to take real estate decisions out of a silo and map them to overall business strategy. Gone are the days when real estate can be viewed just as “housing” and be defined by leases and facilities management. Decisionmaking should be framed by an analytical process that integrates financial and strategic objectives and creates solutions that deliver higher levels of flexibility with lower occupancy costs. Companies are finding that bringing their real estate portfolio’s cost structure in line is a frustrating task. However, there are methodologies to help frame these issues to transform real estate into a high-performing asset rather than a liability. Strategic thinking in all functional areas is essential to survival in the global competitive arena. The first step is to look at key business drivers and understand their interrelationship with real estate. There are five main areas where value can be created: Strategic Fit: Real estate decisions must be driven by the same factors that drive business strategy. What’s good for the people in the organization is what’s good for the company, and applying this requires a fresh look at what employees want, how they work, and how they interact. Market Dynamics: Real estate markets have their own drivers. To understand how those drivers affect what is needed to achieve a firm’s business objectives, it’s important to develop economic models linking market dynamics to macroeconomic factors. Value Structure: The “architecture” of a project’s value is not only a function of meeting housing needs but also of capital costs, accounting effects, investment duration, exit costs, options to alter the investment, and a variety of risk factors. Change Management: Flexibility to respond quickly and effectively to changes in operations, organizational structure, markets, and business strategy is more important than ever. Flexibility is as important to small companies as it is to large conglomerates. Risk Weighing: It is important to translate real estate risks into business risks to present an accurate picture of the business consequences of a decision. Maximizing Real Estate Value Creation In the same way that a well-run company uses investment bankers to analyze its capital structure, companies looking to maximize the value of their real estate transactions should engage an experienced adviser to optimize their occupancy structures to gain insight into possibilities regarding their real estate assets. Cost savings can be created through expert use of financial structuring products and techniques that provide accounting, cash flow, and tax benefits. A commercial building ownership shift has resulted in a different set of needs and objectives for the corporate “landlord,” and thus a different kind of knowledge is required in order to successfully structure transactions. As is the case with any relationship, you must begin by understanding the value drivers for both sides so that a win/win solution can be crafted. Understanding the full implication of these needs allows for a partnership to be created where synergistic objectives result in value creation for all players. Capital markets providers have traditionally looked to lock in returns through long-term contractual relationships, but this is changing. Today, companies are beginning to work directly with capital markets providers in a business partner relationship and, as a result, are increasing both liquidity and flexibility. In ways never before possible, firms can now use real estate as operating assets with finite life cycles instead of tying up costly capital in “bricks and sticks.” In order to benefit from this new paradigm, firms need to understand how to engineer creative, and often complex, transactions to reach their financial goals. Partnering for the Right Solution Despite the trillions of dollars spent on real estate, this area is chronically under-managed. This translates into significant value that is not being tapped and opportunities that are being lost. The need for partnering with outside advisers is clear: Only 8% of financial executives surveyed by CFO Research Services gave their company’s real estate function a rating of “excellent.” Few companies have all the resources they need to be comfortable that they are making the best possible real estate decisions. This experience gap is not surprising, as most in-house real estate professionals will execute complex transactions only a few times in their entire careers. The problem with traditional real estate services is that they’re delivered in the context of the service provider, not in the context of the business being served. The distinction is fundamental and crucial. The business value of real estate decisions has much more to do with operational utility – the effect on revenue and profit – than with real estate market pricing. Market values and pricing are hardly insignificant, but they are just milestones along the way. The goal should not be a real estate deal but rather a business solution in which real estate supports the cost objectives and strategic direction of the company. Hundreds of questions must be answered along the way. An adviser should raise the right questions – business questions first, then real estate ones – and provide a structured, disciplined framework for producing answers and evaluating options. Advisers must understand business and real estate issues and also have knowledge of the capital markets, so that transaction structure meets the company’s unique accounting, profitability, and operational requirements. Advisers use a planning-based methodology, with the integration of accounting, finance, business objectives, and real estate as a core component of their services delivery. Linking business strategy to a company’s real estate platform delivers solutions synergistic with operational objectives. To be truly successful with their real estate assets, companies can use the principles outlined here. By combining these principles with the selective utilization of corporate real estate advisers with expertise in crafting and executing real estate solutions then integrating that with business strategy, companies should realize impressive returns that exceed the competition. This article, adapted from a white paper, “Unlocking the Value of Corporate Real Estate Assets,” previously ran in the September 2005 issue of Corporate Real Estate Leader, publication of CoreNet Global. Derek J. Visocky Senior Advisor Liberty-Greenfield LLP ACG Denver [email protected] (c) 2005 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com