Investment Analysis
The Big Picture
A long-term view can turn corporate real estate liabilities into assets.
By William J. Scarpino |
Companies that are real estate users can learn from today’s tough
economy and past real estate strategies. Reflecting on best practices can
provide insights to defend against future downturns. Real estate decisions, by
their very nature, should include long-term planning. Today’s economic
situation should provoke careful evaluation of real estate deals and
negotiation practices to help companies avoid future retrenchment and the
resultant financial losses.
Resisting the Quick Fix
Short-term solutions often are too alluring when a company is
looking to survive the next quarter. But companies should look further down the
road. For example, tenant companies often fail to understand the importance of
long-term lease terms in an underperforming market. While no one expects
guaranteed increases in retail sales, salaries, or the stock market, every
landlord expects guaranteed rent increases even if the trade area or the
economy deteriorates. Tenants today should seek rent terms that can adjust up
or down with the market.
Incentive plans also should be examined. Instead of rewarding real
estate acquisition specialists based on production, companies might consider
paying part of the bonuses based on performance and long-term real estate terms
that add value to the real estate asset. For developers and landlords, their
leasing agents might be incentivized based on the performance of the tenants
post-construction. Such delayed incentives force leasing agents and site
acquisition specialists to consider long-term success as well as unit openings.
Too often management is focused on input from marketing and
finance in their efforts to drive top line sales without giving the real estate
portfolio proper reflection. Executives sometimes fail to consider the
potential long-term impact of system-wide evolution from the original business
model.
For example, when a restaurant company reassesses what it should
be offering its core customers and elects to change direction, it needs to
appreciate that some of its real estate may be left behind as the core customer
profile changes. Demographics around a location are less likely to change than
the targeted customer of an evolving company. Therefore those stores will
likely become underperforming units and should be abandoned. This attrition
should be planned for in advance and the cost factored into the risk-reward
analysis of making such a bold change.
Real estate is one of the biggest asset segments for any retail or
restaurant company, and moving the concept away from core markets may have a
serious impact on the performance of some locations. If too many are negatively
affected, the change may not prove to be for the better.
Long-Term Vision
Those who manage the acquisition of corporate real estate should
train their people to consider the real estate market in general, in addition
to screening for concept-specific site-usage criteria. Corporate site selectors
typically seek sites that meet the immediate growth needs for their company.
Little thought is given to long-term issues that might impact the value of the
site when it is no longer viable for its primary use.
Also there are various ways to control property that are
advantageous to a company long-term. Building a viable real estate portfolio
should be part of the mission for those who handle the company’s real estate.
That requires looking past the typical acquisition terms needed to operate profitably
in good times. Consideration of those factors that either hinder or enable
redeployment of the site in bad times should be part of the site approval
screening process.
Quality real estate is a commodity. As long as the company controls the real estate
properly they can turn that commodity into needed cash in tough times through
sale-leasebacks or redeployment. The problem is that a real estate portfolio,
viewed as a commodity, does not necessarily enhance the balance sheet. CFOs and
CEOs can be conflicted as to how to justify retaining real estate as a
portfolio when it may hold down quarterly stock valuation.
The reality is that, in the last two years, companies with solid
real estate portfolios have been in a much better position to weather the economic
downturn than those that have leveraged everything for the opportunity to grow
and keep Wall Street happy. Companies such as Boston Market and Metromedia grew
aggressively through initial public offerings and increased store count to meet
Wall Street expectations—only to fail when earnings didn’t materialize.
A once-strong real estate site may become an albatross if it is
secured with too many restrictions. Companies willing to commit to long-term
leases need flexibility to preserve their ability to efficiently and affordably
redeploy the asset when times change. Good sites have an intrinsic value only
if they are not overly encumbered by restrictions. If more corporate real
estate activities were managed with the vision to balance immediate use needs
and long-term redeployment options, fewer tenants would find retrenchment as
financially challenging as it often is.
William J. Scarpino is a principal with Huntley, Mullaney, Spargo &
Sullivan, a lease and debt restructuring firm. Contact him at wscarpino@hmsinc.net.