University of Pennsylvania ScholarlyCommons

Real Estate Papers Wharton Faculty Research

2009

Realizing the Value of Corporate Real Estate Management

Steffen Hartmann

Peter D. Linneman University of Pennsylvania

Andreas Pfnür

Boris Siperstein

Follow this and additional works at: https://repository.upenn.edu/real-estate_papers

Part of the Real Estate Commons

Recommended Citation Hartmann, S., Linneman, P. D., Pfnür, A., & Siperstein, B. (2009). Realizing the Value of Corporate Real Estate Management. Wharton Real Estate Review, 13 (1), 21-33. Retrieved from https://repository.upenn.edu/real-estate_papers/34

This paper is posted at ScholarlyCommons. https://repository.upenn.edu/real-estate_papers/34 For more information, please contact [email protected]. Realizing the Value of Corporate Real Estate Management

Abstract This study examines how corporate real estate management (CREM) departments are viewed within the larger corporate culture. It draws particular attention to the European and U.S. markets, focusing on four specific sectors: Banking, energy, telecommunication, and transport and logistics. The study reveals that although corporate real estate remains an important asset on corporate balance sheets, it is currently "under-managed" in both the United States and Europe, and CREM departments lack prominence in most companies. As a result, companies are not realizing the full value of their real estate assets, and are turning attention to them only in difficult times when operpr ty valuations are generally depressed.

Disciplines Real Estate

This journal article is available at ScholarlyCommons: https://repository.upenn.edu/real-estate_papers/34 Realizing the Value of Corporate Real Estate Management

Comparing the role of CORPORATEREALESTATE 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- ingly important competitive factor in the American corporations. 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,

STEFFENHARTMANN or 40 percent to 50 percent of net income. PETERLINNEMAN One study concluded that competition is ANDREASPFNÜR forcing companies to examine both their BORISSIPERSTEIN assets—especially corporate real estate—

REVIEW 2 1 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% 13%

33%

62% 84%

Cost Center Profit Center Don't know

2 2 ZELL/LURIEREALESTATECENTER 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% 18%

21%

28%

41% 50%

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 2 3 Figure 3: Ownership rates (n=94) 100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0% 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

2 4 ZELL/LURIEREALESTATECENTER 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 2 5 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)

Independence from third parties

Protection of internal processes

Economies of scale of RE costs

CRE competency

Portfolio flexibility

Maximizing liquidity

Other

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

U.S. Europe

2 6 ZELL/LURIEREALESTATECENTER 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 2 7 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

Corporate 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

2 8 ZELL/LURIEREALESTATECENTER 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

Optimizing balance sheet

Optimizing credit rating

Raising capital profitability

Increase flexibility/ Decrease RE risk

Optimizing 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 2 9 Figure 8: Vehicles used for divestments (last three years; n=45; multiple answers allowed)

Europe

U.S.

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%)

Europe

U.S.

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

3 0 ZELL/LURIEREALESTATECENTER 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 3 1 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

3 2 ZELL/LURIEREALESTATECENTER 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 3 3