Redefining Corporate Real Estate

Corporate real estate A CASUAL OBSERVER might conclude that traditional real estate pro- professionals are playing fessionals and corporate real estate (CRE) professionals have little in com- new and important roles mon. Traditional real estate profession- als, such as investors, operators, and in their organizations. developers, focus on real estate as their core business, seeing it as an investment vehicle. CRE professionals view real estate as a non-core business, serving as an infrastructure asset to support a busi- ness other than real estate. Traditional real estate professionals are driven by profitability as measured by internal rate of return, net operating income, and

JULIE E. BENEZET earnings per share. CRE professionals MAUREEN A. WELCH historically have been focused on

REVIEW 19 consumption—most notably cost per ager would, managing costs and maximiz- square foot and vacancy rates. ing value throughout the life cycle in the Until recently, the goals of the two real much same way as their traditional real estate professions tended to intersect only estate peers. While this trend is far from across deal tables. However, that is chang- universal, those organizations that have ing as result of the impact of the twenty- adopted this approach have found that a first-century business landscape. The shift from service to the management of a Internet as a primary channel of goods, portfolio of assets requires not only a dif- services, and information has produced an ferent organizational model than what was environment in which global competition, needed for real estate service delivery, but technological advances, and warp speed also a different skill and mindset for CRE are driving companies to become extreme- staffs. In effect, they are changing their ly cost-conscious and, at the same time, to business model from a non-core business pursue new sources of revenue. Against to a core business within a broader busi- this backdrop, a trend is emerging among ness enterprise. CRE professionals who are finding that, to be successful, they must shift from a role of service providers to their companies (trans- A BRIEF HISTORY action support, space planning, facilities management) to a role of managing the The role and status of real estate in corpo- company real estate as an asset. In this new rate America has changed significantly role, CRE professionals treat the real estate from the days when company CEOs of the company much as a product man- viewed their corporate headquarters as a

Figure 1:The changing role and status of real estate in corporate America

Corporate Brand Scarce Recruiting & Potential and Icon Resource Retention Tool Target

Financial Assets & RE Liabilities Role Commodity Financial Liability

1930 1970 1980 1990 1995 2000 2001 2005

CRE Project Mgmt & Project Mgmt, Transaction Mgmt, Occupancy Planning, Asset Mgmt, Focus Construction Mgmt Construction Mgmt Alternative Officing, Physical Security & Information Mgmt & Transaction Mgmt Workplace Design Disaster Recovery & Data Security & Space Mgmt

20 ZELL/LURIE REAL ESTATE CENTER demonstration of their strength and stay- 1980s, interest rates hit historic peaks. The ing power. Headquarters buildings were high cost of downtown real estate and the intended to be symbolic and iconic—lega- need to invest company capital in com- cies that would leave a lasting impression. puting and telecommunications led to a Thus, in Manhattan in the 1930s, flight of company offices to the suburbs. Chrysler and the Bank of Manhattan com- Interest rates began to drop, and by the peted to build the tallest building in the mid-1980s had fallen to a point where, world, only to be outdone a few years later combined with generous tax credits and by the Empire State Building (Figure 1). easy credit, they fueled a building frenzy. Corporate real estate, known then as “facil- Companies that had banked land or held ities,” was a service function that carried long-term leases profited. Owning became out the directives of the parent company, desirable to lock in current cost. operated buildings and supported archi- The 1970s and 80s saw the introduc- tects, engineers, and other professionals on tion of real estate transaction skills into the major projects. The role required primari- facilities function, bringing in-house pro- ly operational and tactical skills. fessionals with the ability to negotiate mul- Participation in the strategic planning of tiple real estate transactions. While compa- the enterprise happened by rare exception. nies continued with the facilities function, Over the next three decades, little the addition of the real estate function changed for facilities organizations. Real brought the concept of managing the estate was acquired incrementally as desired company real estate as a portfolio of prop- by the business units, placing a premium erties. This approach brought with it on near-term needs over longer-term capi- strategic occupancy planning. While on its tal planning. Facilities and construction face this would seem to be a healthy devel- management remained a focus. Requests opment, CRE remained isolated from for real estate were, in general, handled on business planning despite the fact that a case-by-case basis. Facilities professionals many CRE departments reported to the were oriented toward service, but the serv- CFO. That lack of involvement hampered ice lacked a portfolio approach. many attempts to deliver optimal occu- From the 1970s to the mid-1980s, real pancy planning. estate was considered a scarce resource. As a result of the savings and loans col- There was an undersupply of downtown lapse in the late 1980s, real estate assets corporate real estate, as downtown vacan- held by financial institutions were sold off cy rates averaged around 5 percent to real estate investors. As rental rates between 1979 and 1981. In the early plummeted in the face of massive excess

REVIEW 21 supply, firms rationalized their CRE port- possible terrorist targets. Corporations folios and exited unfavorable leases. reexamined their occupancy plans to deter- During the mid-1990s, many companies mine if consolidation of functions and undertook initiatives to cut sales, general, locations was too risky. Physical security and administrative costs. Although many became a high priority and CRE depart- firms concentrated on increasing “density” ments expanded their scope to include of space use by reducing square footage per business continuity planning and disaster worker, corporations continued to look at recovery. Concern over physical security the workplace as a means of branding. The paved the way for concern over informa- competition for talent was heating up. Hip tion integrity and security. In response to workplaces were positioned as a recruiting Enron, all publicly held firms became sub- and retention vehicle. Amenities (health ject to Sarbanes-Oxley (SOX) compliance. clubs, cafeterias, and casual collaborative SOX requires corporations to demonstrate spaces) were introduced into new corpo- that they have adequate processes and con- rate campuses that emerged. The work- trols in place to safeguard the integrity of place became more flexible and more sup- financial reporting data. portive of mobile, networked workers. In In this new climate, many CFOs have this environment, alternative office and turned their attention to CRE, which is workplace design and space management the second or third largest corporate were key attributes, especially for larger expense. As a consequence, CRE depart- companies. Strategic occupancy planning ments are now expected to view real estate stepped outside of conventional space and facilities as a portfolio of assets and lia- planning to take into account the attrac- bilities. Asset management functions and tion and retention of a competitive work- disciplines, most often associated with the force. Post-9/11, real estate entered anoth- traditional real estate sector, are appearing er down cycle and corporate real estate within corporate real estate, redefining the portfolios experienced unprecedented core in a non-core function. vacancies. Transaction expertise was in The central issue for corporate real high demand again—but now the empha- estate departments today is to show how sis was on dispositions. they add value to the business enterprise. The role of corporate real estate has CRE professionals as well as industry pun- changed throughout the twentieth century. dits have looked at this issue in many ways. However, nothing could have prepared Three pathways to success have emerged: CRE departments for the events that fol- shifting the focus from transactions and lowed 9/11. All office buildings became project delivery to supporting the mission

22 ZELL/LURIE REAL ESTATE CENTER of the corporation; assuming the role of a ness enterprise. A recent survey of twenty- corporate fiduciary; and restructuring the five corporate real estate organizations CRE function. When these pathways conducted by Alvarez & Marsal Real converge, the result is a blending of the Estate Advisory Services LLC indicated corporate business with the real estate, that CRE is focused on both top-line and integrating business acumen with tradi- bottom-line issues (Figure 2). The study tional real estate expertise. found that 80 per cent of CRE depart- ments have strategic objectives. Although cost continues to be the number one SHIFTING THE FOCUS strategic objective, CRE departments are increasingly taking a “balanced scorecard” Since real estate is the longest lead, least approach to strategy—balancing financial, flexible, and second (or third, depending internal operations, customer satisfaction, on the level of information technology and growth and learning objectives. infrastructure) most expensive item on a Business unit alignment, portfolio man- company balance sheet, past efforts to agement, and efficiency all ranked high. align CRE with the business enterprise Taken collectively, they reflect the need for focused on inserting CRE early into cor- CRE to respond quickly and efficiently to porate business planning processes. Such the changing needs of the business, despite early involvement allowed firms to right- the fact that real estate is a long-lead-time size, time, and locate real estate for optimal asset. Workplace performance was also pricing of leases, acquisitions and sales, highly regarded, indicating a renewed materials and construction. Success today, appreciation that the physical workplace however, requires dealing with global com- can positively impact productivity and petition, technological advances, and the ultimately revenues. Approximately half of warp speed of a digital age. To beat these the participants reported that the CRE challenges, companies must find a way to strategy “directly tied back” or “somewhat reduce costs, move faster, and deliver more tied back,” to the corporation’s overall innovation than their competition. As a mission. result, every department of a company has Ideally, strategic objectives are comple- to focus on constant shifts and overhauls mentary. For example, Cisco Systems in products, markets, and services. recently built a new office building with CRE professionals are refining their no private workspaces or cubes. The strategies and attempting to align them Cisco worker functions without assigned more tightly with the mission of the busi- space or other infrastructure than a lap-

REVIEW 23 Figure 2: CRE strategic objectives The top reported CRE strategic objectives and number of participants sorted by balanced scorecard (some participants had multiple objectives)

Financial Customer Satisfaction

Cost Control (18) Business Unit Alignment (8)

Protect Assets (3) Workplace Performance (6)

Quality Services (3)

Manage Portfolio (9) Knowledge Management (6)

Efficiency (7) Employee Engagement (3)

Formalize Processes (3)

Internal Operations Growth and Learning

7 or More Responses 3 to 6 Responses

top and various mobile devices. Not only ing the real estate portfolio in concert does this reduce the demand for real estate, with the ever-changing needs of the busi- but it also more closely mirrors industry ness has financial consequences. Health research that showed that workers are on South, the nation’s largest healthcare serv- average away from their desks 50 percent to ices provider, is a case in point. In March 70 percent of the time. Further, it allowed 2003, the SEC launched formal charges Cisco to showcase its own technology. alleging that HealthSouth systematically overstated its earnings to meet or exceed Wall Street expectations. With more than CORPORATE FIDUCIARY a billion dollars in debt and no access to capital, the company underwent a corpo- Managing costs is the most obvious way rate restructuring and recovery in which that CRE can act as a fiduciary, but CRE CRE played a critical role. HealthSouth can also be a source of capital and an had more than a thousand properties annuity revenue stream. Actively manag- nationwide and abroad. These properties

24 ZELL/LURIE REAL ESTATE CENTER were managed by the operating units in a aging vacancy, others, such as decentralized fashion. Acting as the inter- Bank of America, as part of their core real im CRE department and working in con- estate strategy. junction with HealthSouth’s operating Managing top- and bottom-line results units, Alvarez & Marsal renegotiated leas- is only a part of the fiduciary picture. In es, eliminated under-performing assets, the role of fiduciary, CRE must also focus spearheaded buyouts for hundreds of on compliance. With the advent of SOX properties, and executed facility sale- and its focus on information transparency, lease-backs. The total financial impact activities that have a “material” impact on exceeded $100 million. To sustain this financial reporting get the attention of success, a new CRE organization was cre- senior-level executives. As the second or ated around property types and geogra- third largest expense of a corporation, real phies, standard policies and guidelines estate has become an obvious place of were instituted, and asset performance interest to senior corporate executives. guidelines were implemented. CRE professionals have always measured Many companies have utilized sale- their success by the winning of competi- leasebacks as a source of capital. Bank of tive rates and prices. For SOX compliance America has recently sold 310,600 square the stakes are higher; firms must demon- feet and leased back 74 percent of the strate that they have formal documented space for fifteen years with American processes and adequate controls in place. Financial Realty Trust. Wachovia has sold While few CRE executives have yet to sixty-six bank branches and twenty-nine sign the SOX compliance certification cur- unimproved parcels totaling approximate- rently signed by CEOs and CFOs, the ly 242,000 square feet for $84.1 million awareness that such certification can be with American Financial Realty Trust. compelled has increased the consciousness Unilever has entered into a sale-leaseback among CRE departments of their of about 120,000 square feet with the accountability to the companies. Willet Co. for $87.5 million. Radio Shack According to the Alvarez & Marsal survey, has sold its Fort Worth headquarters to 80 percent of the participants reported German-based KanAm, signing a twenty- that they went through a SOX compliance year lease with renewal options for an effort. However the degree to which the additional twenty years. CRE professionals real estate organization was involved and are also starting to look at ways to generate the number and type of processes audited annuity revenue. Many firms are actively varied greatly, depending on how the com- subleasing space, some as a means of man- pany defined “material.”

REVIEW 25 RESTRUCTURING CRE change it with the changing needs of the business. Centralization is a popular Experience shows that decentralized structure for industries in which office is CRE business units with sole control the predominant space type. Once the over their infrastructure can produce sig- functions are centralized, an outsourcing nificant waste. The real estate industry analysis to determine which functions offers many stories of “Swiss cheese” real should be performed in-house is usually estate resulting from multiple moves performed. It is worth noting that within a business unit’s buildings, leaving although total cost of occupancy that a significant amount of noncontiguous integrates real estate and facilities data is space. This practice has reportedly creat- still considered the Holy Grail of CRE ed cumulative vacancies of up to 20 per- metrics, several organizations that have cent. The real estate expertise within the centralized still do not have responsibili- organization is not fully leveraged and ty for facilities. decisions are made with incomplete McKesson Corporation, a $57 billion information and lack of strategic intent. healthcare services and information tech- To offset the negatives associated with nology company, currently manages 17 decentralized CRE, or one in which real million square feet of real estate. The estate is managed solely by the business centralization transition occurred as part units, many organizations have “central- of larger enterprise centralization initia- ized” the CRE function. Centralization tive to create more leverage, synergy, and implies that both the real estate/facility shareholder value for the corporation. assets and real estate functions (transac- With such a mandate, the CRE unit had tions, project management, portfolio the authority to create a lean (ten peo- planning, space management, and facili- ple), centralized organization with two ties management) are managed by a cen- groups: Workplace Business Partners and tralized corporate services organization. Shared Services. Workplace Business This model is also referred to as “aligned Partners was charged with being a single by function.” point of contact for the business units. Centralization paves the way for con- Key to their success was their ability to sistent, accessible, and reliable data on understand the business of each of their corporate infrastructure, thereby enhanc- customers and to translate that business ing the company’s ability not only to into real estate strategies. Those strategies measure and effectively manage its infra- were communicated to Shared Services, structure, but also to plan, bend and which instituted wide policies, proce-

26 ZELL/LURIE REAL ESTATE CENTER dures, standards and best practices, nego- ture for industries in which there is a mix tiated national contracts, monitored per- of space type (office, manufacturing, dis- formance of national service providers, tribution) or in which the facilities are and served as a primary interface with closely tied to the overall operation of the other McKesson service groups. Essential company (retail, food manufacturing, to the success of both CRE groups was pharmaceuticals). the ability to generate greater flexibility A new model blends the positive ele- in space solutions to support an ever- ments of centralization and decentraliza- changing, mobile workforce and to tion, combining centralized information reduce the overall space requirements. with distributed yet highly integrated Both goals are consistent with the overall teams. This model, referred to as the life- enterprise centralization initiative to cycle model, recognizes the vital relation- enhance shareholder value. ship between the planning and delivery Despite some of the obvious benefits functions. Planning is cross-functional of centralization, many organizations and most often centralized. There are continue to manage CRE in a decentral- several distributed delivery teams that ized fashion (Figure 3). The Alvarez & perform a customer relationships man- Marsal study indicated that approximate- agement function that is usually organ- ly 8 percent of participants continue to ized around a geography or business describe themselves as “siloed,” meaning unit. As in the centralization model, that they worked autonomously. In addi- service providers often play a critical role tion, approximately one-third of partici- in the planning and delivery functions. pants described themselves as “aligned by Regardless of the organization structure, activity,” meaning that the acquisitions/ there is a growing tendency for CREs to dispositions function is centralized and report to a CFO or treasury function. includes both real estate and project man- agement. Several decentralized operations and maintenance teams provide facilities THE NEW CRE management and space management. PROFESSIONAL Often the operations and management teams report to plant operations, but they A direct correlation exists between the can also report directly to a business unit. strategic, fiduciary, and organizational The operations and management teams pathways to success and the required skills may, but often do not, share some com- sets for a successful CRE professional. mon procedures. This is a popular struc- CRE participants in the recent Alvarez &

REVIEW 27 Figure 3: Corporate real estate organizational models CENTRALIZED B1. Aligned by FUNCTION

CRE C

Project S RE A. "SILOED" Organization Mgmt

Business Business Plant or HR, CFO Plant Units Units BUs

Project Space RE RE FM O&M Mgmt Mgmt (FM & Space)

O&M A/D O (FM & Space) (RE & PM)

O&M (FM & Space)

B2. Aligned by ACTIVITY DECENTRALIZED

Marsal survey reported that the most skills in the process. While outside serv- critical CRE skills were general business ice providers can help fill the execution management, financial management, void, knowledge and an understanding and customer relationship management. of real estate and facilities fundamentals When comparing what is required today and one’s own industry remain prerequi- versus what was previously required, sites for CRE success. CRE professionals often describe it as One would assume that shifting from shifting from execution functions to execution to strategic planning and man- strategic planning and management agement requires a retooling of skill sets. functions (Figure 4). While making the In actuality it is more like fine tuning. shift from execution to strategic planning The ability to manage the relations across and management skills, it is imperative functions, negotiate, project manage, that CRE professionals do not overlook coordinate multiple agendas, and com- the importance of general operations municate difficult messages are all skills

28 ZELL/LURIE REAL ESTATE CENTER C. LIFECYCLE APPROACH

DELIVERY Space FM (RE, Project Mgmt, Mgmt Space, FM)

DELIVERY PLANNING DELIVERY (RE, Project Mgmt, (RE, Project Mgmt, (RE, Project Mgmt, Space, FM) Space, FM) Space, FM)

DELIVERY O O&M (RE, Project Mgmt, (FM & Space) Space, FM)

B

that are well known to real estate profes- To move through this identity crisis, sionals. Despite the fact that CRE pro- CRE should redefine itself in a way that fessionals agree with the need to shift and more closely resembles its business unit already have several of the fundamental clients and peers in traditional real estate. skills required to successfully make the Recasting themselves as real estate and transition, there is surprising resistance facilities product managers, as opposed among CRE staff to identify themselves to internal service providers, allows CRE as business people first and real estate professionals to have the best of both professionals second. Somehow shifting worlds. By reframing the corporate real the discussion from dollars per square estate function as one of managing a foot, cost per head, and market rents to highly significant, capital-intensive prod- lifecycle costs, exit strategies, and cycle uct in a business enterprise, CRE profes- times is causing an identity crisis among sionals in fact redefine themselves as some CRE professionals. responsible for a core function in much

REVIEW 29 Figure 4: Required CRE skills s t

n Execution Oversight Strategic Planning a

p & Management i c i t r a P f o r e b m u N

Tech Info RE and Contract Project Vendor General Financial CRM General Mgmt Facilities Mgmt Mgmt Mgmt Ops Mgmt Business Technology Mgmt

Desired Required * General Ops Because this is not a core competency for service providers they feel that this should be a required skill for CREs. the same way as traditional real estate professionals. This shift has the benefit of developing a generation of corporate real estate professionals who combine both business and traditional real estate skills. It also increases their alignment with their business unit customers and the contribution of real estate to the bottom line of a business enterprise.

The authors acknowledge and thank Colette Temmink (Boeing

Realty Corporation) and Frank Robinson (McKesson

Corporation) for their vital contributions.

30 ZELL/LURIE REAL ESTATE CENTER