CEO or corporate real estate decision maker looks for the same fundamental things in an industrial real estate development company that each of us looks for in any business deal. Chief among those fundamentals is trust. We try to find those with whom we have a relationship or with whom we feel we can build a relationship.
This seems simplistic, but think of it in terms of your own experience. Consider what you might do if you are buying a car or a house. You may not know the right person who could sell you the car, or finance your house. So what is your next move? Do you pick up the yellow pages, or do you ask around and try to find someone you trust who can tell you, in turn, whom they trust? A CEO is no different. We all look for relationships of trust, because they solve the three interrelated keys to deal making: Economic Certainty, Deal Certainty and Flexibility.
By Economic Certainty, I am referring to the probability that the final economics of the real estate transaction will be materially consistent with the initial, projected economics. As economic expectations are created in the initial phases of a transaction, a CEO needs to have a high level of confidence that these economics that he is now presenting to his board of directors for approval will be consistent with the final outcome of the project. The most difficult situations that our company has been in (and probably yours as well) occur when budgets are broken and expectations are not met.
For a CEO, having confidence in initial, negotiated expectations is much easier if you have a relationship with the other party. You have a higher degree of confidence that the final outcome will closely reflect your initial projections if you have “been through the battles” with the other side before. These relationships create economic certainty for a CEO. Primarily, you need to know that the other side is negotiating in good faith. Most of us will have been victims at one time or another of a “bait and switch” deal, where the initial promises soon dry up and are replaced with inflated costs.
The second key, Deal Certainty, is the need to have a reasonable expectation of successfully consummating a deal once a CEO starts down that path. This means that there are no land mines waiting to explode on the path that will derail the transaction as it proceeds to consummation. Certainly no one can guarantee an easy path to real estate transaction nirvana, and in fact, it is probably an easier argument to say that there are bound to be landmines. Here again, relationships are the key to working though the issues that are bound to arise.
The third key is Flexibility. This becomes a difficult proposition in any deal given the need for economic and deal certainty. But to the extent that reasonable flexibility can be built into a deal structure, it actually provides additional economic and deal certainty, because it allows a CEO to further ensure that his or her goals will be met. Real estate transactions generally take months or years from inception to completion. There can be significant market changes during this time. A CEO wants to stay lean and agile and able to change direction to react to these market changes as quickly and efficiently as possible. Maintaining flexibility throughout the process for as long as practical requires a relationship. If a change comes up that requires reworking of an existing deal structure, it is much easier to do if there is a basis of trust between the parties. Otherwise, one party may feel that they have been taken advantage of and may call off the transaction.
Each of these three principles aids in developing and strengthening relationships. Failure in any of these three areas on a particular real estate transaction may not necessarily derail that particular deal. It will, however, have an impact on the relationship. Thus, future business is always at stake. We have provided economic certainty by making a well-informed financial deal at the outset. For example, we have had a project where the scope of work was very loosely defined at the beginning of the project. We used this preliminary scope of work to create a budget that provided as much economic certainty as was possible at that point. We then agreed upon a rate of return based on the budget with the understanding that if costs changed, the lease rate would be adjusted to reflect the increase or decrease in cost. This provides economic certainty because the CEO can see clearly through the process where the project is headed and make rational business decisions based on that information.
Deal certainty is created through due diligence. Site issues, zoning/municipal issues, contractor or subcontractor issues, and financing challenges are just a few of the things that can affect the progress of a project. Any of these issues create uncertainty and can derail a project. In almost any project, one or more of these or similar issues is bound to arise. Due diligence will reduce this risk, but when issues arise, a good relationship and a track record of success are the key to resolving these issues and enhance deal certainty.
Flexibility is created by the creativity of the development company. Our company has successfully completed projects where there is a budget, but no clear scope of work, land incentives, free rent incentives, equipment or tenant improvement incentives, and flexibility in expanding and contracting the size of the operation. Certainly not all things are possible, but with a good relationship and some creative thinking, sufficient flexibility can be built into any project.
Through the process of a real estate transaction, a healthy relationship of trust becomes the key that allows for economic certainty, deal certainty, and flexibility. Given two companies with similar economics and a similar real estate opportunity, a CEO will choose the company where he has a relationship of trust. Simple, but true.