Corporate expansion & relocation

Repositioning corporate real estate assets

It’s a way to expand shareholder value

Many companies are recognizing that their operations are no longer ideally located.

By Tracy Barrow

Most successful corporations continually perform detailed analyses of each aspect of their operations to render them as efficient and effective as possible, and to capitalize upon market opportunities. Surprisingly, many fail to include an examination of their real estate operations in these evaluations. These corporations are likely unaware of the potential to enhance their bottom line and increase shareholder value through repositioning their corporate real estate assets.

Over the past few years, sophisticated corporations have begun to examine their real estate operations to more closely align their real estate assets with overall corporate strategies and with their employees and customers. As a result, some enterprises have decided there is little or no opportunity for reducing costs, increasing savings and adding value by way of their real estate operations.

In contrast, however, many corporations are realizing that there is an opportunity to increase value by repositioning their real estate assets. Of this group, some have concluded that they have the resources and expertise to manage their real estate operations in-house. The remaining corporations have determined that real estate is not one of their core competencies and have outsourced the responsibility to third parties that specialize in managing real estate portfolios.

Whether a corporation has chosen to have its real estate holdings managed in-house or by an outside service provider, it is crucial that they are proactively managed. In order to actively manage its real estate operations, a company must evaluate its strategic plan, facility costs, geographic locations, current facilities (both owned and leased) and make a decision whether to lease, buy or build facilities for its future needs.

Strategic plan

The most important question to address is whether the corporation’s real estate assets support the company’s strategic plan and offer enough flexibility to adjust as business and market conditions dictate. For example, if a clothing manufacturer plans to outsource the production of its line to a company in Taiwan, the decision to purchase a manufacturing plant or lease a factory for twenty years would conflict with the plan. Similarly, many banks are now challenging the need to deliver their products and services from free-standing branches by forging alliances with grocery store chains and opening banking facilities within supermarkets. In light of this recent trend, long-term branch bank leases or actual ownership of these branches would probably be a poor use of the bank’s capital and conflict with its strategic plan. Instead, short-term leases would be more appropriate and consistent with this plan.

Facility costs

Real estate costs are being benchmarked to assess the competitive position of an organization. Whether costs are measured by looking at cost per square foot, square foot per employee or expense for each dollar of revenue, companies are discovering that these costs are not fixed. By comparing real estate or facility costs against your prior operating results, peers, or industry averages, you can identify areas of potential cost savings and/or permanent cost reductions.

The starting point for making wise decisions regarding facilities (e.g., whether to close or reduce the size of a manufacturing plant, sales office, bank branch or retail outlet) is knowing exactly what your costs are while retaining the ability to alter your cost structure. When market conditions for companies’ products and services necessitate making such decisions, it is essential to be in a position to act quickly in order to alter the organization’s real estate cost structure and increase the likelihood of future profitability. Flexibility and the readiness to act swiftly are hallmarks of today’s corporate environment.

In addition to benchmarking your costs and possessing the ability to alter cost structure, companies are having their real estate assets evaluated to determine their market value. Such assessments are not being used to determine when to sell real estate assets, but rather to help evaluate business alternatives and measure performance. For example, if you are faced with the decision to shut down a facility, information about the market value of the asset can be used as an aid in assessing the costs involved. Also, use of current market instead of historical real estate costs produces a better result when appraising the performance of a business unit.

Geographic location

Once a corporation has outlined its strategic plan and goals, and challenged its costs, it is recommended that the organization conduct a review of its business locations. Due to changes in demographics, customer or client base, workforce, supplier base or production cost, many companies are recognizing that their operations are no longer ideally located.

If you have a facility that is in the wrong location, the selection of a new site should be driven by the economics of your current and future operations. Once the decision to move is on the table, you have to explore the costs of relocating, including the incentives being offered by local government entities to entice organizations to remain or establish operations in their jurisdictions. Because governments have discovered the need to compete in order to attract or retain their employer base, most offer such incentives as tax abatements, relocation loans and employee training programs. These enticements will play a role in your location decision, but they should not become the decisive factor. It is important to recognize the geographic alternatives and investigate them in order to enhance long-term shareholder value. Such considerations include labor supply and costs, state and local taxes, etc.

Lease, buy or build?

Whether your enterprise is a large publicly held entity, multi-location retailer, professional service firm, closely-held company or non-profit organization, most likely you have been challenged with the decision to lease, buy or even develop on a build-to-suit basis.

The amount of capital invested in corporate real estate has been and continues to be of serious concern to managers, shareholders, corporate analysts, and anyone else interested in increasing value. Nowadays, many corporations are more inclined to lease facilities because leasing generally provides greater flexibility and minimizes current capital outlays.

Corporations considering leasing rather than purchasing facilities can now explore synthetic leasing alternatives. Before the emergence of the synthetic lease, many business leases were treated as purchased assets for book purposes. Synthetic leases do not treat assets as purchases and impart a variety of benefits to the lessee, including lower initial investment in real estate assets, off-balance sheet treatment for the transaction, and increased leverage or the ability to invest capital in revenue enhancing ventures. Additionally, these leases reduce current income tax payments as corporations can claim depreciation on the asset and shelter a portion of their taxable income.

There is some risk with a synthetic lease in that the corporation assumes the underlying real estate risk and will have to compensate the lessor if the value of the asset declines below a predetermined amount. However, the corporation’s increased leverage and the ability to invest capital in new products or to purchase new businesses are incentives that may outweigh the real estate risk. Again, with a thorough understanding of your corporation’s present and future real estate needs, here is a way to enhance your organization’s shareholder value.

The decision to purchase rather than lease is often driven by a desire to cap costs at a predictable level while controlling corporate real estate assets. However, the most recent trend is really the best of both the ownership and leasing worlds: build-to-suit. Here corporations have the ability to dictate the design and development of a property which is configured specifically for them and end up not as the owner but as the long-term tenant, with our without facility management responsibility. With existing commercial property becoming ever more scarce and little, if any, speculative construction underway, build-to-suits are assuming greater popularity among U.S. corporations and developers.

Currently leased facilities

Historically, landlords and tenants have invested much time and effort in arriving at a lease agreement acceptable to both parties. On the tenant side, turnover of key personnel and expansion of the operation (both geographic and product line) have created landlord-tenant relationships that merely involve the payment of the rent and responding to landlord correspondence. Unfortunately, the correspondence may be to notify the tenant of near term lease expiration, with or without an option to extend the term, or request the tenant to vacate due to lease termination. On the other hand, we have seen clients that are paying rent on facilities they are not sure they are even occupying!

Today’s business climate requires a more proactive approach to lease management. In the present environment, tenants cannot actively manage their leased assets without a lease database that tracks option exercise dates, lease termination dates, lease rates and landlord versus tenant responsibility with respect to various maintenance and repair items.

Additionally, it is recommended that corporations create and maintain a central database on leased assets in order to manage the process and support the organization’s strategic goals. For example, many business units and subsidiaries work autonomously; therefore, a central database will be required in order to determine state income tax allocations. Databases are also useful when deciding whether contracts for services (e.g., janitorial, security) should be concentrated to form a smaller group of vendors to reduce cost and increase service quality. Building a database can also help a company follow lease expiration dates that may require capital outlays in the near future to protect a production facility.

Many corporations are becoming better informed about their real estate assets. They are learning that this information, combined with the ability to be proactive rather than reactive, can greatly enhance shareholder value.

Tracy Barrow is senior manager-in-charge of the Corporate Real Estate Services Group for the Los Angeles office of Deloitte & Touche. She has more than eight years of experience providing creative real estate solutions to corporations and clients. Barrow is a member of NACORE, IDRC and the OWE (Organization of Women Executives).