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].
