Linking real estate and strategy to realize gains: a real estate advisor argues that most companies tend to manage real estate as a cost center and fail to recognize the importance of bringing together corporate strategy and the use of property assets.

Much of what could be done to deliver the financial results demanded by stake-holders these days has been done: Businesses have been reengineered, workforces right-sized, costs contained and processes outsourced or moved offshore. Opportunities still exist to make an impact in these areas, but to a large extent, the low-hanging fruit has been picked.

But there is some good news--untapped opportunity in corporate real estate portfolios represents a significant way to bolster corporate balance sheets. According to a recent study conducted by Lowe Enterprises and the University of California at Irvine, corporate America has $1.3 trillion in real estate on the books--and of that, $175 billion represents excess capacity that is lying idle. That is $175 billion in book value; the market value is likely significantly lower.

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These underutilized assets represent just one of many opportunities within the real estate portfolio to create share-holder value. Clearly, there exists significant potential for financial gain, yet most companies are not sure how to unlock the value. An Ernst & Young study found that because real estate has historically lacked management focus, its potential has been misunderstood and opportunities overlooked. CFOs are taking a new look at corporate real estate as a way to improve financial performance because, next to payroll, real estate is a company's biggest cost driver.

Another recent survey of CFOs and other senior finance officers found that 88 percent of respondents tagged 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; in fact, 75 percent of the companies that utilize real estate advisors reported significant cost savings. In addition, 65 percent of respondents said 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 and access to markets, suppliers, and labor. 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 is not also an efficient factor of production, operating losses will undermine any investment gains. Executives today focus on operating returns, with their position correctly being, "We are not in the real estate business."

However, more corporations are now looking at overall real estate performance from a portfolio perspective and re-evaluating how real estate fits into their broader business decisions, and as a result they are reaping impressive financial rewards. As companies drastically change how they do business, they are also redefining the workplace.

Consider Apple Computer Inc.: It is no longer just a computer company; it is a design, media and entertainment company. International Business Machines Corp. has become a services conglomerate. Not only are companies re-positioning themselves in the marketplace, but their housing needs have been impacted dramatically.

For example, a recent study conducted by The Gallup Organization for CoreNet Global found that in 2010, 21 percent of companies will have their employees working remotely up to half the time, compared to just 7 percent 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 is 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.

Linking Real Estate Decisions To Business Objectives

A central element in 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. History is clear about the consequences for not aligning real estate and strategy: U.S. companies took more than $500 billion in real estate losses in the last business downturn.

Learning from the errors of the past requires that real estate decisions better balance the housing needs of the company with more asset flexibility and financial risk mitigation. Real estate decision-making must be framed by a rigorous analytical process that integrates financial and strategic objectives, and creates solutions that deliver higher levels of flexibility with lower occupancy costs.

Yet, according to McKinsey & Co., "Even with clear guidelines and best practices, many companies still fall short when deciding how much to spend on occupancy and how to manage real estate portfolios." As companies seek ways to cut costs to maintain or improve operating margins, they find that bringing their real estate portfolio's cost structure in line is frustrating. However, there are methodologies to help frame these issues and to transform real estate into a high-performing asset rather than a liability.

Strategic Business Drivers

The problems that stem from not linking real estate and strategy are indisputable, and the surmountable challenge is how to integrate the two. A vital 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:

1. Strategic Fit: Real estate decisions must be driven by the same factors that drive business strategy. Today, the productivity of human capital is a key component of a company's success, and that means a new way of thinking about the workplace. What's good for the people in the organization is what's good for the company, and applying this requires taking a fresh look at what employees want, how they work and how they interact.

2. 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 is important to develop economic models that link market dynamics to macro-economic factors. Using the same methodology that capital markets investors employ to understand market trends, risks, pricing and future values will result in a solution that is not only flexible but cost-effective in the long term.

3. 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. Value can be maximized by utilizing financial structures that optimize the most important value components and minimize risks.

4. Change Management: The 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, single-product companies as it is to large, diversified conglomerates. No worthwhile real estate planning effort today can neglect to take a hard look at all possible contingencies that may lie ahead, and it must make appropriate provisions according to their probability and potential impact.

5. Risk Weighting: It is important to translate real estate risks into business risks to present an accurate picture of the business consequences of a decision. Looking at the entire picture means deciding which risks are consistent with expected business returns, and which should be avoided because their downside potential out-weighs the upside.

Maximizing value creation from real estate decisions is one of the most challenging issues facing senior management today. Turbulent and fast-changing market conditions, combined with increasingly demanding stakeholder expectations, create an extremely difficult business environment. There is an increasing need for asset flexibility, cost containment and the mapping of real estate decisions to business strategy, yet most companies lack the expertise to operate effectively in this area because they simply don't execute large, complex deals with a high degree of frequency.

With the advent of easily accessible databases, market knowledge--historically the key offering of the traditional real estate broker--is now a commodity; such knowledge is now a component, not the entire real estate solution. Using that knowledge, and coupling it selectively with help from experts in crafting and executing complex real estate solutions that integrate with business strategy, can go a long way toward extracting maximum value from a company's real estate portfolio.

Derek Visocky ([e-mail]) is a Senior Advisor with Liberty-Green-field LLLP, a Denver-based provider of corporate real estate consulting and tenant advisory services. This article is adapted from a recent white paper issued by the company, "Unlocking the Value of Corporate Real Estate Assets."

RELATED ARTICLE: takeaways

* A recent survey suggests that more than 13 percent of U.S. companies' corporate real estate assets are lying idle, and their market value is lower than book value.

* Corporations should be looking at overall real estate performance from a portfolio perspective and re-evaluating how real estate fits into their broader business decisions.

* Real estate decision-making integrates financial and strategic objectives and creates solutions that deliver higher levels of flexibility with lower occupancy costs.

* Adding advisory help to a broad market knowledge base can do much to successfully executive strategies and extract maximum value from a real estate portfolio.