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Real Estate Strategy for Fast Growth Companies

Let’s consider the corporate headquarters of a fast growth service business. Suppose that 1) they have a preference for keeping everyone together in one contiguous space, 2) they desire to strategically minimize cost and risk, and 3) growth rate is a variable based on many factors. What is the smart way to scale facilities?

A first exercise is an assessment of current space utilization and capacity. From this, we can also get some interesting metrics such as real estate cost/staff member, cost/seat, SQFT/seat and SQFT/staff member. These metrics will be useful in extrapolating future demand. It is also worth considering the absolute constraint in expanding the maximum number of accommodated staff. For example, depending on industry and culture, in the short term it may be possible to put 2 or even 3 people in a single office, but at some point even another single person becomes unfeasible. Sometimes, and especially in suburban locations, the constraint becomes parking. In any case, you’ll want to understand this in order to create an expansion timeline.

The next step is to perform a growth sensitivity analysis. This is a projection based on anticipated growth and variances within two standard deviations of expectations. At this point you should also consider sensitivity to four external forces, 1) Economy, 2) Competition, 3) Technology and 4) Government Regulation, which could potentially impact your forecast. Using these projections and dividing by the desired SQFT/seat metric, you can anticipate minimum and maximum space demand. In general, you’ll want to define requirements in annual increments and ideally be flexible enough to cover both high and low space requirement estimates. In a perfect world, the company is paying for only the seats needed for each year, with the guaranteed ability to take additional space as necessary.

It is not always a perfect world, of course, and real estate is often inflexible and requires a high cost of construction. However, it is possible to design an occupancy strategy to be reasonably flexible and support a high growth or variable growth company. Here are a few strategies:

Buy or Build Large: The company designs or acquires a multi-tenant property that can accommodate significant growth over a long horizon. It then leases out the excess space until needed, including perhaps options to terminate the other occupant’s leases if necessary.

Lease Large: Rather than own, the company acquires space in a much larger project and secures expansion rights. These could be a series of outright “free” options, paid “reserve” options, Right of First Refusals, Right of First Offers, Guaranteed Takedowns, Right of Contractions and possibly even a direct lease of space with liberal sublease rights. Each has various advantages and risks, and every landlord will have a different tolerance for each, so they are often used in combination based upon the user company confidence on their absolute future need and timing.

Most companies will favor leasing rather than owning because it shifts a portion of the risk to the landlord, reduces both upfront and expansion construction costs, and often provides much greater expansion flexibility. Favoring a very large institutional landlord, such as a well-capitalized REIT, typically improves these benefits even further to protect upside expansion needs (although may fare worse if the user ever needs to downsize).

Finally, realize that while you cannot always cover an absolute ideal scenario at every level of possible growth rates, you can always have a plan for each. Smart companies ask, “What if…” and make sure they have a logical answer for each potential outcome.

amazon prime logistics

Amazon Prime’s Logistics Strategy

A few months ago, I joined Amazon Prime.  That’s a $79/year program that Amazon developed that gives members free 2 day shipping on Amazon-stocked products (which is most of the stuff that they sell).  For me, having nearly anything I want conveniently delivered anywhere I want in two days is fantastic.  However, the second time I bought from them, I was given a choice:  Free 2 Day Shipping, as I had signed up for, or Free No Rush (5-7 day) Shipping with a $1 credit to their Amazon MP3 Music Store (with most songs priced $1 or less).

Now the offer isn’t a huge incentive, but you have to appreciate the strategy behind it:  Many times customers just don’t need things as fast as we’re able to deliver them.  By effectively “polling” my needs, Amazon just created an amazingly flexible logistics model.  Can you imagine having a pool of pending deliveries that you can pick and choose when to fill and when to ship based upon your labor and transportation capacities?  That’s what Amazon has accomplished.

The strategy is absolutely brilliant:

  1. They’ve got customers to pay a premium for shipping (most orders over $25 ship free 3-5 day anyway).
  2. They’ve created a membership organization which builds loyalty – if you’re in the Prime program, you’re likely to buy from Amazon or at least check there first.
  3. They are determining customer’s true time requirements, and thanking them for the flexibility with a token MP3 song – a near universal currency in today’s world.
  4. By having up to 7 days to select orders based on size, weight, or delivery area,they are able to optimize shipping strategy to lower costs.

Now, based around the requirements of their 2 day must-deliver products, they can fill trucks and planes based on available capacity.  They can have geographically revolving flights (Pittsburgh on Mondays, Cleveland on Tuesdays, for example).  They can lower inventory based on order time.  If their suppliers can supply them with inventory in just a few days, perhaps they don’t carry the inventory at all!

If your business delivers products, think about how you might apply this to your business:  A brand loyalty program, rush delivery when your customers need it, flexibility when they don’t, a small reward to thank them for both the information and permission to be flexible.

It happened that, as I was placing my order I was about to leave town for a week so certainly didn’t need it in a rush.  I took the credit.  A handful of times since then, I was in less of a hurry so received more credits.  Less = More.  I recently used $6 in credits to buy a $5.99 MP3 download of the Rolling Stones’ Sticky Fingers.  Thanks Amazon.

multiple real estate locations

Real Estate Best Practices: Companies Managing Multiple Locations

Any corporation with more than one office/branch/site is large enough to have real estate portfolio objectives. With just a handful of locations, the C-level executives are likely very hands-on in determining the best solution as real estate opportunities or decisions present themselves. Once the number of sites grows to a point where that oversight is delegated though – whether placed under the responsibility of another staff member such as Regional VP’s, Controller, VP of Finance, General Counsel, or a dedicated Director of Real Estate – there are three styles that the management can typically be classified under:

1. Reactionary – Most direction comes from the field or operations groups as needs arise. Most often these type of corporations are decentralized in terms of real estate decision making. While the executive group must ultimately approve major obligations, the business case is usually created by a local or regional manager and the real estate department oversight role is to help facilitate the transaction.

2. Proactive – Under this category, corporate management is involved in defining some type of regular real estate objectives and the real estate overseer is often a relative direct report to the CFO or COO (sometimes their VPs in larger groups). Their actions are driven primarily by expiration dates of upcoming leases, and they usually communicate regularly with the field to determine needs well in advance or with sales/marketing to anticipate new facility requirements.

3. Strategic – The real estate group is the driver of real estate actions based upon corporate objectives and a portfolio approach is applied to reducing costs by evaluating efficiencies, forecasting demand, assessing market opportunities, and considering logistics if applicable.

In terms of involvement, each one of those levels successively requires a greater time investment. In terms of net profit, each level also successively provides a greater return to the corporation. Why?

Lets look at an expansion scenario under each of those management styles. Let’s say that a location runs out of space for employees or product and needs to expand. For purposes of simplicity, we’ll assume that the corporation only leases space and does not desire to own property:

Reactionary – If left to chance, the timing of this event rarely occurs in coordination with the natural expiration of a lease. Therefore, the company’s only realistic option is to negotiate with the existing landlord. This situation is not competitive because the number of prospective bidders with contiguous space is limited to one. Further, the objectives met are usually that of the local manager and not necessarily the corporation. These objectives could be the same, although they may not be. The local manager’s compensation may not be directly tied to expenses, so the lowest cost solution might not be the driver – perhaps he cares more about investment of his time and/or business disruption. Certainly those are important factors, they just might not be top priority from a C-level viewpoint. This group may or may not use tenant representation, often selecting a local tenant rep “if needed” or for relocations but not necessarily on renewals.

Proactive – Under proactive real estate management, the corporate RE manager would have been alerted in advance through regularly scheduled conversations with the field. The space demand might have been solved by diverting some business to another branch with capacity (empty seats or warehouse space for example), or alternatives such as splitting off a function such as accounting or marketing into a new office could be considered. Even if the preferred solution is to keep everyone together, figuring out how to split the operation – and assuring that you have enough time to execute if required – will open up more alternatives both with the existing landlord and with other locations. This will almost certainly result in a more competitive market rental rate and terms. This group often has tenant representation.

Strategic – Because the strategic RE manager routinely forecasts space demand and tracks inventory of open seats (office) or storage capacity (warehouse) factored against growth rate metrics several years in advance, this need was probably anticipated occurring during the original lease negotiations. If so, the tenant likely has either expanded at the last lease event or has some type of negotiated expansion option in place. Alternate strategies such as diverting business to another branch, reconfiguring the space to add additional capacity, or a lease termination option may be utilized. In any event, the more options that have been explored or considered, the greater the flexibility of the tenant, and the lower the ultimate cost. This group virtually always has an integrated tenant rep corporate services partner in a strategic role.

So why doesn’t everyone use the Strategic Method? Well, you have to walk before you can run, and the Reactionary Method is the one that will occur by default since companies tend to focus on running their business and delivering their product. Real estate just happens to be seen as consequential to the operations, not a strategic component. In firms with fewer locations, the C-level executives and the local staff are usually well in sync so can usually do ok with a Reactionary plan. The issues arise as the company grows and management is not conversing regularly enough with whomever is determining real estate solutions. Eventually, the company usually gets stuck in some bad lease situations, or a decision is made by a local manager who promptly leaves the company, although his poor decision on a 5 year (or longer perhaps) lease obligation remains. At that point, the company usually ratchets up a level or two.

The reason that investment in real estate strategy provides such a high rate of return on time investment is that: 1) the savings are usually direct to the bottom line (ie. there is no cost of goods or significant capital investment), 2) the results are usually transparent to operations (saving an additional $.50/SQFT/Year on the lease won’t make any difference to the employees or production) and 3) the effects are multiplied over a number of years (3-10 are typical). Investing time in studying and effecting the best facility solution will always result in less cost to the corporation.

key performance metrics

Corporate Real Estate Best Practices: Key Performance Metrics

Every business has a learning curve as it grows, and the collective wisdom learned along the way becomes an invaluable knowledge base.  This is especially true in regard to your facility strategy.  By analyzing  what was done right and what could be improved in each new location or lease renewal process, you can develop rules to achieve the greatest return and avoid pitfalls.

If your firm has multiple branch locations, try this simple exercise:  Take your annual Total Occupancy Costs (Rent + all Operating Expenses) and divide by an annual revenue metric such as Adjusted Gross Profit or Gross Sales.  For example, if a location has $240,000 in TOC and AGP at that location last year was $5M, then your real estate costs represented 4.8%. Now do that for each site.

What you’ll find, of course, is that each location has a different real estate cost as a percentage of revenue.  The magic question is:  WHY?

Some locations will be more efficient than the others.  You need to dig out the reasons behind that efficiency. Likewise, some locations will be grossly inefficient.  You can also learn from them what not to do.

If you are a sales organization, perhaps one facility has more seats/SQFT than the other.  If each sales person brings in an average of $200K per year, then every 5 extra seats in that facility represent $1M in revenue.  Fit them in without increasing the square footage, and you’ve just added some real value for your organization.

You can be certain that there are more savings to be had by developing best practices for your unique business operations than in negotiating another $1/SQFT off of the rate.

The same is true when it comes to using a real estate representative.  While local market knowledge is always important, it is more critical that they have a detailed understanding of these nuances of your company:

  • WHY renew or relocate?
  • WHERE is the ideal location?
  • WHO will use the space and in what way?
  • HOW does the space compare to your competitors?
  • WHAT makes a layout efficient? and most importantly, 
  • WHAT is the long term objective for this part of your business and how can you structure a lease that will help accomplish those goals in the most cost-effective way?

Using metrics like the one described above, and taking the time to understand what makes your space efficient for your operations or not, will ultimately deliver more cost effective space solutions.

Dubai commercial real estate

Case Study: The Burj Dubai

The world’s tallest building is perhaps the greatest architectural and engineering accomplishment of man.  While most construction methods used for our local homes and buildings have not changed in the last 50 years or so, the Burj Dubai pushes the envelope of technology, sustainability, and functionality.

The fact sheet is amazing.  For example, the concrete used in the structure would be sufficient to build a sidewalk 2,065 miles long – about the distance from NYC to Monterrey, Mexico.

Here’s an infographic with more detail:

worldstallesttowertheburjkhalifa_52d2af15985d4_w540

Market Rate Audits for commercial leases

One of the easiest and most effective ways for a corporation to keep real estate costs low is to regularly perform Market Rate Audits on their leased locations.  Often many companies get caught up in reactionary tasks such as simply handling leases as they come up for expiration, so they never get ahead of the curve with a proactive approach.

Here’s how the Market Rate Audit usually works: Whether a firm has just a handful of locations or several hundred, each lease with less than 5 years remaining in term is evaluated and compared to actual available alternative spaces in their respective markets.  Rather than rely on the general occupancy and rate statistics published by the large landlord rep firms such as CBRE, JLL or C&W, this exercise involves actually identifying specific spaces that, if the lease were expiring in the next 12 months, would be feasible for a relocation.

While nobody has a crystal ball to predict what rates will be in the long term, rates for the next 18-24 months can be forecasted surprisingly well by looking at occupancy, absorption, and property under construction. Knowing existing feasible alternatives combined with construction – it takes generally 18 months or longer to get entitlements, permits, and build a new commercial facility – can give a very precise picture of what rental rates will be over the near horizon.

Many people fail to consider that leases are just like mortgages – a financing tool to occupy or control a property. And just like mortgages, when rates are low, it makes sense to restructure them and capture the lower rate.  Likewise, if rates are escalating and lack of new construction would not provide additional supply – the rules of supply and demand apply here of course – it may also make sense to lock in early before rates increase further.

The benefits of a Market Rate Audit to the corporation are:

  1. They become proactive to manage rental costs to take advantage of low points in the market.
  2. They become aware of any significant increases – many markets have rebounded to rates above their prior peaks – so no surprises.
  3. If market terms become unfavorable they have adequate time to plan alternatives such as build to suit options or even shifting facilities to other markets.
  4. The audits can be done on contingency with the auditing firm only billing to the extent that savings are immediately realized.

The Market Rate Audit is a low risk, low cost, smart portfolio strategy to take a proactive approach to corporate leases.

7 Red flags that may indicate the need for a lease compliance review

By Ed Harris
(Editors Note:  Ed Harris is VP of Commercial Tenant Services, a NYC-based auditing firm that specializes in corporate lease review. We hope you enjoy this guest article.)

Few areas hold as much impact on capital outlay as real estate and leasehold expenses. Ensuring that your company is not overpaying is integral to fiscal management.

  1. Significant Jumps in Operating Expenses / Additional Rent
    Performing a simple trend analysis of your year-to-year operating expense obligation is a must. And while inflationary and market forces generally create an escalating building operating expense profile, when you see a marked jump in expenses issued to you, a red flag should rise. Causes of significant jumps might include new and potentially lease impermissible capital projects, new expense categories not reflected in your base year, new contracts or vendor changes and/or related party issues, and newly increased or above standard services which are not reflected in your base year.
  2. Change in Property Ownership / Property Manager
    A change in property ownership or property management should always trigger a lease audit. Property management changes create a very real risk of affecting accounting category integrity which is integral to an apples-to-apples comparison to your base year level. Management fee levels and composition, related party vendors, and changing service levels are also common building operating expense issues when a building changing ownership or management. Another potential trap fall in a building transaction is the tenant estoppel which, if not carefully worded, has the potential to sign away rights or leverage. Finally, once a building changes hand, future audit finds and recoveries may become complicated should overcharges be identified in years under previous ownership.
  3. Building Undergoing Capital Improvements or Renovations
    If you are walking into your building and notice construction – audit your landlord. Renovations and capital projects may be subject to your lease operating expenses exclusions, and every project should be audited for permissibility under your lease. And while you are most likely obligated to reimburse the landlord for a true building operating cost, you probably are not obligated to reimburse your landlord for increasing the value of his/her building if it does not reduce building operating costs in the future. And if your building had undergone renovations and/or capital improvements in past and unaudited years, it may not be too late. Those costs were most likely amortized across future years, and there may still be an opportunity for avoid ongoing expenses if they prove to be impermissible per your lease exclusions.
  4. Your Lease is Commencing / Expiring
    Perhaps the most valuable times to have a lease audit performed are at the commencement and expiration of your lease. If you occupy under a base year lease, the valuation of your base year will have material impact on your leasehold expenses throughout the term of the lease. It is in your direct interest to both validate all charges in Year One, and to validate expense levels so as to not undervalue your base year. Likewise, lease audits should always be performed as a standard practice at any lease expiration. Not only might you lose rights to recoup any overcharges after vacating the premises (audit windows), you may lose significant leverages after your move. Lease audits and the potential uncovering of over- or mischarges may also have a material impact on any lease renewal negotiations and construction of lease amendment/renewal language.
  5. Sizable Shifts in Building Occupancy Levels
    Accounting for accurate building occupancy levels is integral to an accurate gross up methodology and can have enormous implications to your operating expenses obligation. This can be significantly magnified vis-à-vis fixed versus variable occupancy-level driven expenses should the vacancy rate in your building be sizable. And of course it directly benefits the fiscally conscious tenant to ensure that occupancy shifts are accurately reflected within a given expense period.
  6. No or Limited Backup Supplied to Annual Reconciliation Statements
    Just as you would not accept your credit card statements if they did not itemize your charges, accepting an annual reconciliation on face value is fiscally unwise. Yearend reconciliations can carry significant and lease term long financial impact – particularly if your lease terms include caps or index-driven escalators. And any failure to timely challenge a landlord’s computations and/or inclusions may forfeit your rights thereafter per potential audit windows as discussed above. Accepting a rudimentary reconciliation, even one broken down to expenses per billing category is to trust your company’s finances to an outside party with a vested interest in maximizing its profits. Whenever an annual reconciliation crosses your real estate department’s desk without sufficient back up to verify expenses and calculations, a lease audit should automatically be triggered.
  7. Building or Landlord is in Financial Straits
    While it might not always be obvious, it is in a tenant’s best interests to periodically inquire into a building and its owner’s financial wellbeing. These are difficult financial times, and few sectors have been hit as hard as commercial real estate. Commercial Tenant Services (CTS) has uncovered multiple examples of landlords in difficult financial straits materially overcharging their tenants. And while we would never suggest that such a situation directly underlies the overcharge in any specific example, the coinciding of the two – a landlord in financial distress and overcharges to its tenants – can be a recurring theme.

It is important to remember that auditing your landlord issued expenses is your right. It is sound fiscal practice and required compliance protocol in many of the most efficiently run companies in the North American markets. Lease audit has become commonplace, and chances are your landlord has been audited by its tenants many times before your inquiry. Nowadays, landlords expect to be lease audited and have generally already prepared for your call.

Edward Harris is the co-founder of Commercial Tenant Services and has over twenty-five years of real estate finance and lease audit experience. Mr. Harris holds degrees in physics and engineering from Columbia University, and an MBA joint degree in Real Estate Finance and Operations Research from the Graduate School of Business at Columbia University.