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ne theme underlying Jones Lang LaSalle’s Corporate Real Estate Leadership Forum in October 2000 was the similarity of experiences among real estate managers no matter where they are based. Crafting effective relationships with business units remains a top priority of all, for example, as do managing shareholder expectations and balancing time pressures. Another common challenge is that of managing change–both in attendees’ own role as asset manager as well as the change brought about by their organizations when they commit to implementing programs to improve work space performance. (Part One of this report on the day-long forum–Jones Lang LaSalle (JLL) hosts several such events each year for clients — appeared in the March 2001 issue of Site Selection.)
Issues raised in the morning discussions, including the critical role of broadband communications technology, are pertinent to real estate managers globally, noted Andrew Gould, international director at JLL, who is based in the firm’s London office. Additional matters also are at play in Europe, he related.
“In the movement if shared service center to the Asia-Pacific region, we are seeing global cost arbitrage; organizations are moving people and facilities and functions to a lower cost location.” — Alison Cooke, Jones Lang LaSalle |
“The process of Eurozone consolidation and convergence is causing virtually every international corporate organization to look at the way it operates across Europe,” he noted. “A second factor has become something of a Holy Grail, certainly in the U.K., and that is the notion of risk transfer and PFI.” The U.K. government’s Private Finance Initiative was a means of transferring ownership of government real estate assets and the servicing of them to the private sector. The approximately 16-million-sq.-ft. (1.5-million-sq.-m) portfolio consists of about 650 buildings in 140 locations.
“Corporate financial restructuring is a third trend we are seeing, particularly in the way financing is procured and the risk profile is managed,” Gould said. “There is a big difference between corporate real estate in Europe and in the U.S., which is that in the U.S. about 30 to 35 percent of real estate is owned. In Europe, about 70 percent is owned, which represents a great opportunity, but also a great constraint–it’s like lead boots on the feet of many corporations.” Financial markets, too, are evolving in Europe and elsewhere, prompting companies to explore indirect financing vehicles.
These trends are unfolding against the backdrop of political convergence and currency and tax harmonization in the European Union, not all members of which are participating in the migration. “For many corporates, the expansion into Europe over time, whether organic or through acquisition, has been country by country,” related Gould. “A sea change is under way, a process of consolidation across the European region,” he added, which will fundamentally change expansion strategies. Convergence already is happening, as the common currency–the euro–illustrates.
Cost Drivers in the Asia-Pacific Region
Alison Cooke, based in the firm’s Hong Kong office, discussed the evolution of shared service centers and other trends in Asia. In February, Cooke was promoted to the position of national director and head of the team based in Hong Kong. “Companies effectively are stripping out the shared services from the corporation and the business units functionally, financially and–especially in Asia-Pacific–geographically, as well,” Cooke said. “In the movement if shared service center to the Asia-Pacific region, we are seeing global cost arbitrage; organizations are moving people and facilities and functions to a lower cost location.” Some places in Asia have specific skill bases already in place relative to others thanks to this development. Cooke cited one academic estimate predicting a transfer of 50 million white-collar jobs from the West to India in the next few years. “In terms of a GDP boost to India’s economy, that’s $1 trillion a year at the salary levels involved.”
By way of example, Cooke pointed to America Online’s recent opening of an email service center in The Philippines. The center, which supports U.S. operations, started with 20 employees. It how has 600 workers, and the company has built in capacity to double that figure in the coming months.
Companies considering such a move have a complex set of criteria to weigh, such as labor availability vs. condition of the infrastructure. “The much higher levels of efficiency and infrastructure in such places as Hong Kong and Singapore come with a cost, typically five to 10 times higher than most major locations within the region,” Cooke observed.
Cooke reviewed some of the costs associated with shared service centers in Asia, and she noted another regional trend: “A lot of Asia-Pacific countries are getting on board the notion that they have to pull people into their countries to mitigate some of the negative factors we’re seeing. We now see tax breaks, import duty breaks and free or cheap land.”
Residual Value and Other Risk Factors
Tom Bomba, JLL’s senior director and expert in portfolio management matters, discussed ways in which earlier work he had spearheaded on portfolio structuring is being applied in the marketplace. Prior to joining Jones Lang LaSalle, Bomba had led an alliance of consultants, corporate real estate executives, academics and others in a group effort to redefine portfolio management in the corporate real estate context (see Management Strategy, March 2000 issue of Site Selection, page 218). Bomba’s co-presenter at the Leadership Forum was Lee Utke, a corporate real estate manager at Whirlpool Corp., Benton Harbor, Mich.
“On average, for every 10 percent more real estate that a company owns than its peers in the same industry, it returns one percentage point less to its shareholders.” — Tom Bomba, Jones Lang LaSalle |
Occupancy duration, flexibility needs and risk management are at the heart of space occupancy strategies, noted Bomba. The latter refers to risk associated with business strategies, the company’s financial position and operations. “There are three ways to manage that risk,” he suggested. “One is by improving your demand-forecasting–know what it is you will need. In other words, better define your future uncertainties. The second way is to know what you have in terms of space. Use a complete data set and rigorous analysis around that data set. Thirdly,” he continued, “have some good flexibility strategies and exit strategies.”
Portfolio management is chiefly about resolving the own-or-lease dilemma and managing the various risks associated with that decision. Residual risk is the key issue to address, Bomba stressed, referring to the likelihood that an owned facility will no longer be needed after a point. “It begs the basic question: Should you be in the real estate speculation game?” he pointed out. If so, there’s some stiff competition from those used to analyzing and jumping into and out of markets, Bomba noted. “You are serving a different master,” he said. “You can optimize financially only after you optimize occupancy.” What’s needed is a duration-matching exercise, he said.
“If I need to be in a place for 20 years, I get a 20-year lease,” he explained. “If I’m uncertain [about duration], I can build a structure around both at the individual asset level and at the portfolio level. I might be there 10 years, get a few options and manage my risks such that at the tail end I have some small exposure to landlord negotiation risk, but I can manage that by the types of assets I go short on, or lease. I wouldn’t do that with a data center, or some other capital-intensive facility. But I can do that with office space.”
Bomba also outlined ways to “move strategically” or in such a way that the real estate decision impacts the strategic position of the corporation. “You need to run numbers to see how [a location decision] will impact your corporation,” he said, “because the answer won’t always be to own or to lease. The key is to know what you are managing against. Are you trying to minimize risk? Are you trying to minimize costs? Are you trying to maximize flexibility?”
Citing analysis carried out in the portfolio management modeling exercise–which was organized by The McMahon Group, San Francisco, where Bomba worked as a consultant at the time–Bomba demonstrated how a finance professor found a significant negative correlation between corporate returns and real estate ownership. “On average, for every 10 percent more real estate that a company owns than its peers in the same industry, it returns one percentage point less to its shareholders,” related Bomba. “That means that if I’m a Dow Jones Industrial Average company, I get maybe a 17 percent return to my shareholders. If I own 20 percent more real estate than my peers, then I’m only giving my shareholders only 15 percent return. That 2 percent impact on total return to shareholders is huge,” he argues. The analysis indicated that this correlation tends to be more pronounced in high-beta, or more volatile, industries from a financial risk perspective.
“Business needs drive occupancy needs,” Bomba concluded, “which together with the capital markets drive costs of capital.” Uncertainty is the biggest factor–otherwise the process would be simple. Whirlpool’s Lee Utke has been working with Bomba and his colleagues on ways to maximize the appliance manufacturer’s global property portfolio.
“We don’t just want to talk about ownership vs. leasing, but rather about control of the real estate asset and how we want to use it,” noted Utke in describing the nature of JLL’s assignment. Whirlpool’s portfolio was managed regionally, and one difference across regions that Utke sought to address was how the regional managers viewed residual value. “In one part of the world, they were very optimistic about residual value, because it increased the overall returns of the project, it would meet their hurdle rate and it was approved.” Other issues came up in other regions, such as which discount rate to use, where inconsistency was rampant. Numbers can appear consistent region to region or asset to asset, but assumptions behind the numbers can differ.
A team comprised of finance department executives–to whom the real estate function reports–and JLL consultants worked on the project. “At the end of the day, we wanted to provide a roadmap for determining the best vehicle for controlling an asset,” Utke related. The company’s portfolio is roughly split in half in terms of owned vs. leased. “We were able to develop a fairly complicated cash-flow model that integrates with EVA
A New Look at ‘Strategy’
The Leadership Forum’s final discussion centered on developing a strategic approach to corporate real estate. The essence of this challenge is to balance the two important tasks of meeting the requirements of the business units and their financial objectives and, secondly, doing that within the context of the corporation’s objectives. “It’s hard to balance those two tasks, but doing so is essential to being a good strategist,” observed Debra Moritz, international director in JLL’s Chicago office. Another key component to developing a strategic role for real estate is to identify ways in which it can add value. “We can and should look at each and every asset and see if there are ways in which we can maximize value,” added Moritz.
Clients participating in the discussion agreed that much of that value is tied to implementing a consistent approach to decision making. One JLL client pointed to more widespread use of a common lexicon across the organization where property assets are concerned, as well as a more streamlined decision approval process and a more efficient planning process as benefits of emphasizing on strategy.
The client, from a major financial services organization, is in the midst of developing a property-specific strategic plan. “The need there is to communicate the plan, because if you ask people in one location what the strategy is for assets of a certain classification, hopefully they would give you a consistent answer,” he reasoned. “And their counterparts in other locations may not give the same answer. A strategy that isn’t communicated, formalized and documented is not worth very much. You’ll find yourself executing on a tactical path in a manner contrary to what you are trying to accomplish strategically.”
Richard McBlaine, CEO of Jones Lang LaSalle’s Global Consulting practice, recalled a meeting he had with a senior manager at a prospective client’s office that taught him an important lesson in how clients are now perceiving the notion of strategic value, which is with skepticism. “Rather than ‘strategy,’ I think you should use the term ‘decision framework,’ ” the executive told McBlaine. “We want a framework in which we can make more informed real estate decisions that when taken at an incremental level support the overall objectives of the business in a more intelligent way.”
The lesson of that meeting, McBlaine related, was that thinking about strategic planning as a mere intellectual exercise is not worth doing. “If you do not get traction with the strategy, if it does not change the things you do immediately after doing them or while in the process of developing the plan, then don’t even bother.”
