Realizing the Value of Corporate Real Estate Management

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					                             Realizing the Value of
                             Corporate Real Estate

Comparing the role of        CORPORATE            R E A L E S T A T E has

                             always been a valuable asset on corporate
corporate real estate
                             balance sheets, even if many companies do
                             not realize this is the case. Maximizing the
management in European and
                             value of real estate has become an increas-
American corporations.
                             ingly important competitive factor in the
                             ongoing globalization process. Various
                             industry research studies over the last ten
                             years indicate that more than 25 percent
                             of corporate assets are invested in real
                             estate and that total occupancy costs of
                             corporate real estate represents 5 percent
                             to 8 percent of total (pre-tax) gross sales,
                             or 40 percent to 50 percent of net income.
PETER        LINNEMAN        One study concluded that competition is
ANDREAS            PFNÜR     forcing companies to examine both their
BORIS        SIPERSTEIN      assets—especially corporate real estate—

                                                       REVIEW        21
and their processes in order to increase            with a large number of leased and/or
market share, maintain competitive posi-            owned properties, with the majority of
tions, and increase shareholder value.              participant companies having annual
Thus, research recognizes the significant           total revenues of more than €1 billion
value of real estate (to non-real estate            (Europe, 27 percent; U.S., 21 percent) or
firms). But in spite of this recognition, cor-      more than €5 billion (Europe, 61 per-
porations continue to “under-manage” real           cent; U.S., 66 percent).
estate assets and resources. In part, this is           In order to establish the importance
because corporate real estate management            of corporate real estate, it is necessary to
(CREM) departments lack prominence in               define the role of CREM in a company.
most companies. As a result, this valuable          The objective should be the creation of a
part of corporate balance sheets goes large-        return from real estate without distract-
ly unnoticed and undermanaged.                      ing the focus from the firm’s core busi-
    We surveyed corporate real estate               ness. Furthermore, CREM should make
executives of European and U.S. non-                a contribution toward the strength and
property companies in the banking,                  competitiveness of a company by ensur-
energy, telecommunication and trans-                ing that company-owned resources are
port and logistics industries to assess how         used effectively. In short, increase prof-
they manage their real estate holdings.             itability of the company from both core
The primary focus was on companies                  and non-core operations.

Figure 1: Cost vs. Profit Center (n=112)
                 Europe                                                   U.S.

                 5%                                                      3%




                Cost Center                Profit Center                  Don't know

    It is interesting that nearly all (97 per-       our survey have the self-perception of run-
cent) of U.S. and 83 percent of European             ning CREM as profit centers, but effec-
companies run their CREM departments                 tively are run as cost centers.
as corporate divisions. CREM as a stand-                 A major task of CREM is to identify
alone legal entity is found in only 3 per-           strategic challenges focusing the company
cent of U.S. and 12 percent of European              and to manage their effects on corporate
enterprises. As displayed in Figure 1, most          real estate. The planning and decision
U.S. (84 percent) and European (62 per-              horizon of CREM therefore is concentrat-
cent) firms run their CREM departments               ed on the development of long-term
as cost centers, and only 33 percent of              potential for success. CREM should
European and 13 percent of U.S. CREM                 identify and evaluate the economic and
departments are organized as profit cen-             technical trends driving the firm’s real
ters. Further, only 20 percent of European           estate portfolio, improving the firm’s com-
CREM departments have a real estate                  petitiveness. A study by Asson in the
strategy against which they are held                 Journal of Corporate Real Estate indicates
accountable. This means another 13 per-              that in addition to the financial optimiza-
cent of European CREM departments are                tion of real estate portfolios, this form of
run as profit centers but without account-           cooperation leads to greater flexibility, cost
ability. Further, a number of companies in           certainty, and higher service quality.

Figure 2: Property information system (n=112)
                 Europe                                                       U.S.

                  1%                                                              11%
                          12%                                        18%




               No property information system
               Basic property information database
               Complete property information system used by the real estate department
               Complete property information database system shared with clients
               Don´t know

                                                                                REVIEW           23
 Figure 3: Ownership rates (n=94)










               1997                  2002                 2007                    2012

                          Europe Total                     European Telecommunication
                          European Banking                 European Transport & Logistics
                          European Energy                  U.S. Total

     The existence of a property database         estate ownership places on the bottom
 that provides adequate and timely infor-         line. Real estate ownership rates remain
 mation (such as business needs, staff            excessively high among European compa-
 requirements, facilities, occupancy costs        nies as compared to their U.S. counter-
 and market data) is essential for facilitating   parts. The ownership rate in Europe is
 effective strategic planning of corporate        about 56 percent versus only 25 percent in
 real estate. But only 50 percent of U.S. and     the United States (Figure 3).
 41 percent of European CREM depart-                   While European companies have
 ments use dedicated property information         reduced the property ownership gap rela-
 systems, while 18 percent of both U.S. and       tive to their U.S. counterparts, Europeans
 European CREM departments have prop-             still own far more corporate real estate,
 erty database systems that are shared with       though slightly decreasing real estate own-
 the end-users. More than a quarter of            ership is the norm. Five years from now,
 European and U.S. CREM departments               European companies still intend to own
 use only a basic property information sys-       50 percent of their portfolios. Hence, the
 tem (or none at all) (Figure 2).                 top level of European corporations fails to
     It is imperative that U.S. and European      assess the value of capital tied up in corpo-
 companies grasp the financial burden real        rate real estate. Moreover, given that the

respondents are CREM staff and may fear        percent from 1997 to 2007, and is
that less “owned property” translates into     expected to drop to 37 percent by 2012.
lower employment for their group within            The sale of portfolios and individual
the corporation, there is a natural bias       properties is necessary at European com-
among CREM towards owning corporate            panies to move from the predominant
real estate. There is no reason to believe,    ownership model to the more efficient
however, that this effect influences results   lease model. Exceptions exist for highly
to a greater or lesser degree in the United    specialized assets, but the general rule of
States or Europe. Finally, higher ownership    thumb should be to lease and deploy cap-
rates among European companies result          ital to core business activities.
from less pressure to maximize profits and         Although the challenges for CREM
corporate value.                               departments are quite similar in the
    Focusing on the higher rate of             United States and Europe, there are
European ownership, considerable differ-       marked differences in the rationales for
ences are found across industries. The         leasing versus owning corporate real estate.
highest ownership rate is in the energy        Specifically, European companies show a
industry, where European companies             much greater desire to shield internal
own about 79 percent (expected to drop         processes (Europe, 58 percent; U.S., 16
to 75 percent by 2012), due to special-use     percent) and maintain independence from
properties and the formerly government-        outside landlords (Europe, 53 percent;
controlled energy markets in many              U.S., 21 percent) (Figure 4). The desire to
European countries. A large decrease in        keep processes and management internal
ownership rates is forecast for the            to a CREM department is possibly the
telecommunication and banking indus-           result of less well developed rental markets.
tries. Over the last ten years, real estate        Research by Linneman and Pfirsching
ownership rates in the telecommunica-          (WRER, Spring 2008) demonstrates that
tion sector decreased from 77 percent to       current corporate real estate standards used
59 percent, and from 72 percent to 52          to make the own-versus-lease decision are
percent in the banking sector. In both         seriously flawed:
telecommunication and banking, the                 The decision rule generally
ownership rate is expected to drop further         employed is that only if the present
in the next five years (to about approxi-          value of future rent is less than the
mately 45 percent). The ownership rate             present value of costs of self-owner-
in the transport and logistics industry is         ship of the space (net of deprecia-
lowest, decreasing from 46 percent to 42           tion benefits and expected proper-

                                                                         REVIEW         25
    ty appreciation) should the firm                 economies of scale plays an important role,
    lease rather than own… The cor-                  compared to only 26 percent of U.S. com-
    rect model for the own-versus-                   panies. This indicates that European com-
    lease decision must compare the                  panies either mistakenly believe real estate
    present value of profits the corpo-              is a core operation if done on a grand scale,
    ration expects if they lease versus              or that that U.S. companies have learned
    the present value of expected prof-              that non-core functions should remain
    its if the company decides to own                non-core. In fact, such non-core functions
    its real estate.                                 have higher costs, especially when done on
    The authors analyze the difference in            a grand scale. Further, portfolio flexibility
profits generated when a company leases              (relocating personnel, downsizing,
versus owns, concluding that “The intu-              expanding) is important for approximately
ition of this result [to lease] is simply that       55 percent of both U.S. and European
by moving capital from low yielding real             respondents. This is not surprising, as
estate to high yielding core operations,             portfolio flexibility is a prerequisite for sat-
companies increase profits.”                         isfying the rapidly changing space require-
    For 57 percent of European compa-                ments of corporate end-users in an ever
nies, maximizing real estate-related                 more global and competitive environment.

Figure 4: Criteria for owning or leasing (n=112; multiple answers allowed)

from third parties

      Protection of
internal processes

    Economies of
 scale of RE costs

 CRE competency




                       0%          20%           40%              60%             80%             100%

                                                     U.S.       Europe

26      ZELL/LURIE          REAL   ESTATE   CENTER
 Figure 5: Basis for ascertaining tied-up capital (n=112)

  Book value

Market prices

No response

                0%          20%              40%               60%              80%             100%

                                                  Europe       U.S.

     One of the main tasks of CREM                   centers measure their opportunity costs of
 should be to measure capital requirements           corporate real estate on a market value
 and the opportunity costs of real estate            basis, while more than two-thirds of cost
 capital. Unfortunately, most CREM                   centers use book value.
 departments use metrics that fail to cap-               Another factor driving the opportunity
 ture the true opportunity cost. As shown            cost of tied-up real estate capital is each
 in Figure 5, a stunning 62 percent of               firm’s required rate of return. As depicted
 European and 55 percent of U.S. compa-              in Figure 6, more than half of U.S. com-
 nies measure their capital on the basis of          panies use the weighted average cost of
 book value. In comparison, only 38 per-             capital (WACC), 10 percent refer to cor-
 cent and 25 percent of respondents in               porate profitability goals, and 5 percent
 Europe and the United States, respectively,         use real estate profitability goals in their
 use market values to determine the value            cost of capital analysis. In contrast, a mere
 of tied-up capital.                                 18 percent of European companies use
     Using book value to calculate the               WACC, 19 percent rely on corporate prof-
 opportunity cost of tied-up capital is in-          itability goals, and 16 percent use real
 appropriate. Not surprisingly, costs come           estate profitability goals.
 into play when companies are faced with                 It is interesting to note that a high per-
 the decision to choose a method to value            centage of respondents either do not have
 company portfolios (book versus market).            a required rate of return for their real estate
 Since updating market value is more cost-           holdings, or do not know if they have one.
 ly than calculating book values, the latter is      This suggests that many senior executives
 a less expensive—though misleading—                 have not recognized the significant value
 approach. Interestingly, only 46 percent of         tied-up in their real estate assets. In addi-
 CREM departments that are run as profit             tion, CREM departments generally do not

                                                                                REVIEW          27
 Figure 6: Required rate of return for ascertaining opportunity costs in tied-up capital (n=112)

       Interest on
      debt capital

Weighted average
   cost of capital

 profitability goal

       Real estate
 profitability goal

      Don´t know

                      0%          20%          40%            60%             80%       100%

                                                   Europe       U.S.

  know how to measure the opportunity                among corporate real estate staff that core
  costs of capital tied-up in real estate. Since     operations should be the prime destination
  most companies view real estate as an              of capital (however flawed the perception
  operating asset, they place little emphasis        of those same individuals may be that
  on the opportunity cost of these assets.           holding real estate is a means to this end).
      Although only 10 percent of respon-                 U.S. companies indicate the goal of
  dents in both Europe and the United                investing in the core business is of primary
  States note problems stemming from earli-          concern at a response rate that is almost
  er acquisition decisions on CREM portfo-           identical to their European counterparts.
  lio management performance, CREM is                At the same time, U.S. respondents lag
  rarely an integral part of the corporate           their European counterparts when it
  acquisition process. Hence, there is little or     comes to believing that increasing prof-
  no consultation with CREM as part of               itability by raising capital through the sale
  acquisitions, with CREM consulted as to            of assets is a key goal. Other important rea-
  potential effects only after the acquisition       sons for property divestment include opti-
  strategy has been developed by senior              mization of balance sheets and generating
  management.                                        long-term equity. Operationally, CREM
      The fact that investment in the core           respondents also believed that increased
  business was, by a slight margin, the goal         flexibility in their portfolios was a divest-
  most cited with respect to divestment sug-         ment goal (Figure 7). All too often, they
  gests that there is some understanding             sell only when they are distressed and such

  Figure 7: Corporate goals achieved through divestment (n=112; multiple answers allowed)

 Investing the proceeds
        in core business

   Freeing up long term
capital by lowering total
        occupancy costs

          balance sheet

            credit rating

         Raising capital

     Increase flexibility/
       Decrease RE risk

            tax situation

                             0%   20%           40%            60%           80%            100%

                                                      Europe    US

  sales access urgently required capital. But    comfort with the uncertainty of securiti-
  such sales generally occur into weak           zation success. Obtaining capital from
  economies and capital markets, as that is      properties is something that corporations
  when corporate distress generally occurs.      typically prefer to do quickly, quietly,
      Sale-leasebacks, while utilized by         and with certainty (Figure 9).
  both European and U.S. respondents,            Securitization is the exact opposite.
  trailed outright sales of (primarily) indi-        The divestment of properties is gener-
  vidual properties to private investors         ally achieved via single-property sales, as
  (Figure 8). This suggests such sales occur     opposed to portfolio sales. This indicates
  only when they are no longer of use to         that divestment occurs on a reactive basis,
  the company. The lack of responses of          as opposed to part of a larger strategy. We
  U.S. participants with regard to use of        conclude that in both Europe and the
  securitization of properties results from a    United States, the strategic involvement of
  combination of two factors. First, there       CREM in corporate divestment activity is
  may be a hesitancy to disclose such con-       limited, with dispositions driven by neces-
  fidential information. Alternatively, it is    sity. In such distressed circumstances, firms
  possible that U.S. respondents have dis-       are not basing sale decisions on market

                                                                           REVIEW         29
 Figure 8: Vehicles used for divestments (last three years; n=45; multiple answers allowed)



         0%              20%                40%             60%                 80%                100%
                           Sale-leaseback                 Securitization (mortgaging/forfeiture)
                           REIT                           Private Investor
                           Initiation of RE funds

 Figure 9: Packaging of divested properties (last three years; n+77; multiple answers
 allowed; response rates were Europe 66%, U.S. 75%)



            0%           20%                 40%             60%                80%                100%

                    Individual asset/property sale                   Package/portfolio sale

timing or opportunistic pricing, and fail to         tions addressed the internal destination of
capture the highest value for their assets.          proceeds when a property is divested
    Once the decision is made to divest,             (Table I).
the allocation of divestment proceeds is an              The preponderance of companies,
essential component of corporate real                regardless of where CREM is housed or
estate portfolio management, as the bene-            reporting responsibilities, indicates that
fits of divestment proceeds should align             proceeds from divestment of property go
with corporate interests. One of our ques-           to the general corporate treasury. Among

30          ZELL/LURIE   REAL     ESTATE    CENTER
European companies, seven companies                  status of real estate within their companies
noted that 100 percent of divestment pro-            in a positive light. With some exceptions,
ceeds go to the unit that used the real              the views are similar across U.S. and
estate. A further eight responded that users         European companies (Figure 10). There is
share the proceeds either with the finance           agreement among U.S. and European
or CREM department (or with both). In                CREM staff that real estate is predomi-
only six of the companies do the divest-             nantly an operating resource, with some
ment proceeds go to the CREM depart-                 believing it is also a financial investment.
ment. In practice, the most common                   However, we question their belief in real
model is that the corporate treasury                 estate as a financial investment, as when
receives all sale proceeds. Only a small             asked how opportunity costs of corporate
number of corporate users benefit from               are measured, less than 20 percent of
divestments of surplus properties they for-          European respondents used WACC.
merly occupied. Nearly half of European              Corporate and real estate profitability
and U.S. companies say they reinvest                 goals were both mentioned by just under
divestment proceeds into core business               20 percent of European respondents and
activities.                                          fewer than 5 percent of U.S. respondents.
    In spite of its relatively low corporate         Of European and U.S. respondents, 47
status, CREM staff generally perceive the            percent and 28 percent, respectively, said

Table I: Appropriation of divestment proceeds
 European respondents
 Model    Corporation/Finance       Unit using real estate    CREM group    # of mentions
   A            100%                        0%                      0%           33
   B             50%                       50%                      0%            2
   C              0%                       50%                     50%            3
   D             80%                       20%                      0%            2
   E              0%                        0%                    100%            6
   F              0%                      100%                      0%            7
   G             50%                       30%                     20%            1
   H     Don’t know/No response                                                  20

 U.S. respondents
 Model    Corporation/Finance       Unit using real estate    CREM group     # of mentions

   A           100%                        0%                      0%            26
   E              0%                       0%                    100%             2
   F              0%                     100%                      0%             7
   H       Don’t know/No response                                                 3

                                                                               REVIEW        31
 Figure 10: Perception of real estate among CREM staff

                    RE is viewed as
               financial investment

                   RE is viewed as
              an operating reource

       Divestment of non-essential
            assets is completed to
               the extent possible
          Internal experience with
        the marketing of corporate
               real estate is strong

       All spaces and their layout
   and outfitting are standardized

       Maximizing economies with
      centralized purchasing for RE

      We have been able to reduce
       real estate costs drastically
                in the last 10 years
Quality of our space has improved
 considerably in the last 10 years,
 with user needs being met more

   User satisfaction has increased
      notably in the last 10 years

              CREM group follows
              known best practices

           We are utilizing our real
         estate (leased and owned)
            at maximum efficiency

   Flexibility in allocation of space
       and holdings has increased
      markedly in the last 10 years

   We have been able to increase
 the profitability of our real estate
      holdings in the last 10 years

                                        0%        20%          40%         60%         80%        100%

                                                                 Europe       U.S.

 they did not even know how corporate real                (versus just 23 percent of U.S. respon-
 estate opportunity costs were measured at                dents) that their companies have been
 their firms.                                             able to increase the profitability of real
     Finally, we take issue with the claim                estate holdings over the past ten years.
 by 63 percent of European respondents                    Aside from reiterating the problem we

 32       ZELL/LURIE        REAL        ESTATE   CENTER
see with measurement, we note that 60              Despite a growing body of research on
percent of European respondents admit-         best CREM practices, the “under-manage-
ted real estate is a cost center within the    ment” of corporate real estate assets con-
company, with just over 30 percent view-       tinues. Inadequate attention is paid to
ing it as a profit center (U.S. participants   resource allocation, and the skill sets
responded to the same cost versus profit       required to effectively manage key func-
center question, with roughly 83 percent       tions of CREM are lacking. The inability
and 17 percent, respectively). Of the 63       to define the role of corporate real estate,
percent that responded that the prof-          combined with the inability to measure
itability of the real estate had improved,     the lost opportunity cost of corporate real
we believe some focus only on land val-        estate, obscures senior management’s view
ues that probably have generally risen         of the underlying value which is locked
over the past decade.                          into many corporate real estate portfolios.
    Financial education and performance        Among CREM staff, real estate is still pri-
standardization within the field of corpo-     marily viewed as a cost center, which fur-
rate real estate management must improve       ther supports evaluating corporate real
both at the upper echelons of executive        estate from the perspective of both the bal-
management, and within the CREM                ance sheet and operating resource alloca-
departments. Without a proper under-           tion. Corporate real estate is not a core
standing of the financial and operational      business of these firms. However, regard-
impact of corporate real estate on compa-      less of whether companies recognize it or
ny balance sheets, senior management will      not, corporate real estate remains a valu-
continue to own their corporate real estate.   able and under-utilized asset.
In turn, decisions on how to manage that
real estate, whether owned or leased,
remain based on flawed reasoning. While
survey respondents indicate that CREM
performance has improved over the last
several years, it is unclear what metrics
they use to arrive at that conclusion, given
that in some cases, they “work independ-
ently,” while in other industries basic
financial metrics were not referenced in
terms of measuring the opportunity cost of
corporate real estate.

                                                                         REVIEW        33

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