Managing real estate assets as carefully as you manage interest rate risksMichael Stonereal estate assets Mortgage lenders watch interest rates as intently as politicians watch opinion polls. They know that even small rate movements up or down can have a huge impact on loan demand and dictate rapid adjustments in market strategies. But the interest rate changes that affect a company's business will affect its internal operations as well, requiring staffing changes that will either reduce or increase the need for office space. Unfortunately, companies don't always make this important connection. As a result, they often end up making major real estate decisions on the fly, reacting to real estate crises instead of anticipating their real estate needs. Companies that don't manage their real estate will be managed by it, and this is not a prescription for success. Managing your real estate is as important as hedging your interest rate risks. In both cases, an effective strategy will boost your bottom line, while a poor one will undermine it. Banking industry regulators require financial institutions to "stress test" their portfolios to determine in advance how interest rate changes will affect their earnings. Mortgage companies should apply a similar test to their real estate assets. If rising rates and falling loan demand leave you with more employees and more space than you need, where will you cut back? If refinancing rebounds, will you need more space than you have? Which markets will you need it in? Do you have room to expand in your current locations, or will you have to find additional space elsewhere? Step one: Conduct an audit Before you can begin to answer those questions, you have to know exactly how much space you have, where it is located and how it is being used. A comprehensive audit will give you that baseline information, but this is only a starting point. It is an aerial photograph, not an X-ray. Calculating a company-wide, average-square-footage-per-employee ratio will provide the close-up view you need by establishing a benchmark for determining how the space allocation in each office matches its productivity. You shouldn't expect to find the same ratios in all offices, but you should expect to have good reasons for the variances you find. For example, you might want to allocate more space per person in an office that regularly generates above-average loan volume, but if your least productive office also has an above-average space ratio, someone should ask why. You should scrutinize rental rates in the same way. A high-rent building in a premier location may be justifiable in a market in which corporate image is an essential part of your strategy, but it is worth questioning whether the same quality of space is required in all of your locations. Your audit should focus not just on the amount and location of your real estate, but also on the fixtures and equipment you own or lease. Lacking that information and a context for analyzing it, one mortgage company sold the equipment and furnishings from two unproductive offices it had closed instead of storing and shipping the furnishings (far more cost-effective than buying new) to the office it was opening in a more promising location. Step two: Develop a strategy Mortgage companies apply sophisticated strategies to virtually every aspect of their complex business, but when it comes to managing their real estate, the strategy seems to involve little more than hoping for the best. As a consultant friend once told me, "Hope is not a strategy." You can't know in advance what real estate decisions you will have to make, but you need a context for making those decisions and a framework for implementing them, and you should standardize this process as much as possible. You don't want to recreate the wheel every time you set out to select a building, sign a lease or furnish an office. You don't want to approach every real estate decision as if it is the first one you have ever made. The strategy you adopt should establish an internal process for reviewing and negotiating leases to ensure that you deal consistently with landlords in all locations. To the greatest extent possible, incorporate the same or similar provisions in all of your leases. For example, if you negotiate a strong sublease option in one lease, you don't want to forfeit that benefit elsewhere. It should also standardize the specifications for office design, furnishings and equipment. Buying multiples of the same desks, fixtures and computers will give you the benefit of bulk pricing. And if you end up closing an office in one location, you can ship the furnishings and equipment elsewhere (as the aforementioned mortgage company should have done), knowing the styles will match and the connections will fit. If the office design is standardized, you won't have to hire a space planner and an interior designer every time you open a new office; you can just give the landlord or the contractor your existing plans, reducing both the cost and time required for the make-ready preparations. Step three: Read your leases You need to note critical dates and obligations in your leases and track them carefully, so you don't forfeit opportunities or trigger penalties by missing notice deadlines or failing to satisfy lease requirements. Make sure you know what penalties your leases impose and what options they provide. Some leases contain "go dark" provisions, requiring tenants to maintain specified staffing levels - essentially, keeping the lights on - even if they decide to close the office. Do your leases allow you to sublet space? Do they give you attractive options, such as the right of first refusal to acquire additional space in the building if you need it? And are those option periods long enough to give you time to make sound business decisions? These provisions are negotiable and highly desirable. They give you the flexibility you need to respond to changing market conditions. For example, you may decide to close an unproductive office sooner if a sublease option will reduce your ongoing liability under the lease. Staffing up may be more appealing and feasible than relocating if you know you can expand in an existing building. You want to make sure your leases help you take advantage of opportunities and dont prevent you from doing so. Plan ahead This is the reason you have a real estate strategy - so that you can anticipate and avoid problems on the one hand and identify opportunities and take advantage of them on the other. Your strategy should include an organized process for tracking office market conditions in areas in which you have offices or may want to open them. That research will establish the groundwork for a move well before you have to make it. If you decide in March to open a new office in Phoenix, you will have at least a working knowledge of available properties and market conditions. You will know if you are entering a tight market in which landlords are unlikely to make concessions or a market in which landlords will give you almost anything you request. Without this essential advance planning, instead of negotiating for space, you will be scrambling for it, increasing the risk that you will end up with offices that are too small, large or expensive for your budget. Again, this is the essential difference between managing your real estate and being managed by it. Even the most prescient planners sometimes guess wrong, of course. The market that looked so promising in the fall may have turned sharply south when you open a new office in the spring, while an area that had seemed permanently stalled has shifted surprisingly into overdrive. A standardized, organized process for managing your real estate will help you here, allowing you to move quickly and confidently to implement the decisions you make. If you are uncertain about the outlook and want to test the waters before making a commitment, seek a short-term lease or negotiate a month-to-month arrangement to satisfy yourself that this is a market in which you want to play. Make sure the lease gives you the right of first refusal on available space in the building so that you can expand without relocating if the market takes off. You want to avoid space that leaves you landlocked with no option other than to move. Even relocating across the hall or from one floor to another can be expensive. To limit your exposure on the down side, include a sublease provision so that you can lease your space to another tenant if you decide to leave before the end of the lease term. Also, try to find space that requires minimal tenant improvements. If you are working from a standardized office design, you will know up front precisely what you need. If you can keep out-of-pocket expenses to a minimum and reduce the changes required for a replacement tenant, the landlord can afford to be more flexible if you have to negotiate early termination conditions. The more landlords have invested in your space, the less flexible they can afford to be. Flexibility is the goal of your real estate management plan. Reducing your real estate risks and maximizing your real estate opportunities will ensure that your real estate decisions will advance your company's core business strategies instead of getting in their way. Michael Stone is president of The Stone Group, an Austin, Texas-based corporate real estate service provider for the financial services industry. He may be reached at (512) 732-8700 or e-mail [email protected].
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