In this article, the real estate business includes the industries and professions that design, finance, develop, construct, market, and manage land, infrastructure, and buildings. In contrast, business real estate refers to an organization’s workplaces. The choice of locations, properties, and financing methods can help or hinder a company’s strategy, raise or lower its costs, and promote or impede its productivity.
Look around you. If you’re on land, you are in real estate. It is ubiquitous and indispensable. For most businesses, it is the largest or second-largest asset on the books; yet, because it is everywhere, real estate is easy to take for granted. And because it affects everyone—customers, employees, investors, regulators, neighbors—real estate is not easy to manage. My aim in this article is to distill real estate maxims that will help board members, executives, and others meet this challenge.
Business real estate is not merely an operating necessity; it’s a strategic resource. But it rarely captures senior management’s attention. In many organizations, real estate remains a reactive, second-order staff function, focused on discrete projects and deals rather than on the company’s broader strategic issues. Location and layout choices are made within business units, driven by short-term needs, and based on conventional wisdom. Proximity to headquarters can take precedence over customers’ and employees’ preferences. The five maxims discussed below—intended not for real estate specialists but for the leaders who guide them—highlight the issues that senior managers need to understand.
1. Manage the Portfolio
A company’s portfolio of real estate holdings should be more valuable to the enterprise than the sum of its individual sites. To ensure this, executives need a high-level view of their real estate situation, which they won’t get from the site-by-site analysis that is generally the focus of internal staffs and systems. Executives need a “snapshot” of the company’s footprint: the locations, the land and building types, the utilization and condition of major facilities, the lease terms and operating costs, and the financial and environmental risks. Leaders also need a dynamic, moving picture of where corporate strategy is driving their real estate holdings and of how the footprint could change depending on the route they take. When they compare the snapshot—tables, maps, and photos—with the “movie,” made up of robust scenarios of a company’s known and potential needs, the analysis will probably reveal some misalignments. The company may have too much space in one location and too little in another, or the wrong kind of space in certain areas. The analysis will also show which leases are expiring and when, their amounts and costs over time, and how the locations and sequence of expirations could complicate, or even block, future actions.
Armed with these insights, a leader can take advantage of portfolio opportunities that a site-by-site analysis will not reveal. For example, offices that do not need to be downtown can be relocated to less costly (though not necessarily distant) submarkets. Redundant facilities can be sold, subleased, or vacated.
The portfolio approach is especially important when a company is going through a major change, such as a merger, an acquisition, or a divestment. Rationalizing an organization’s real estate—that is, matching space and facilities (supply) to strategic and operational needs (demand)—can be as important as rationalizing the workforce. The process of equating supply and demand, physically, financially, and operationally, often involves relocations, closures, and dispositions. WPP Group, the global advertising and communications giant, captured a $100 million windfall by promptly selling the Tokyo building of J. Walter Thompson after acquiring the agency. And when divestments loom, real estate is often the most visible and valuable asset—witness Bear Stearns, whose Wall Street building was its principal asset when the firm collapsed.
Portfolio analysis can also inform leaders about a property’s costs and uses over time. The total costs of operating and maintaining a facility during its useful life (typically around 50 years) can be many times the original costs of building or renovating it. Taking a portfolio view allows for better planning of maintenance spending and of the timing of building subleases and sales. By comprehending this life cycle holistically, leaders can anticipate—and possibly avert—project-level actions that compromise portfolio-wide gains. For example, a business unit might lease additional space to accommodate growth or a reorganization, unaware that another unit has vacant space in a nearby building the company owns; or an executive might make expensive headquarters alterations while more junior managers are pursuing cost reductions.
Caveat: Beware the shadow portfolio.
As companies strive to reduce costs through outsourcing, they should keep in mind their indirect responsibility for facilities that house outsourced functions. Workers at those sites may not be company employees, but their productivity depends heavily on the location and configuration of facilities. In addition, companies can be subject to stakeholder activism and even legal action if workplace health and safety standards aren’t met. Companies that have outsourced a significant portion of their functions—Citigroup and Nike, for example—have found themselves with substantial de facto portfolios that must be managed as adroitly as the real estate they hold directly.
2. Build In Flexibility
The nimble organization ensures that it has maximum flexibility throughout its real estate holdings—even if that means paying more up front in some instances. Flexibility can be financial (leasing instead of owning), physical (designing modular space), and organizational (redistributing work).
Financial.
Companies that prize flexibility tend to own less and lease more. Pfizer, for example, traditionally owned most of its facilities to ensure control and believed that owning was less costly over time than leasing. However, as industry changes led the company to dispose of facilities rather than undertake expensive retrofits, Pfizer found that divesting specialized R&D facilities was exceptionally difficult. The company plans to examine leasing and flexible-use options when it needs new R&D space in the future.
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Pfizer
When Pfizer began overhauling its sprawling collection of real estate in 2006, leaders discovered that nearly 15% of each research dollar was going to facilities depreciation and site-operating costs. The process of real estate rationalization cut that figure in half.
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Lease terms themselves offer a way to maximize flexibility. Shorter terms, with more frequent and earlier termination dates, expansion and exit clauses, and renewal options, can help a company adapt to changing circumstances. Coordinating the end dates of leases, subleases, and exit clauses in adjacent spaces also allows organizations to shift or disband operations. Savvy managers negotiate leases as they do equipment purchases: They establish a base price and define an array of options for which the company is willing to pay a premium, depending on the flexibility it needs—for example, exit rights after one year (instead of the typical five) for a unit that is up for sale or modular options on new space for a fast-growing start-up. Corporate real estate managers can make intelligent decisions about how much to pay when they understand the variability of business needs. In volatile times, up-front costs may be low relative to the hidden operational costs of having too little or too much space, or the wrong type of space in the wrong place.
Physical.
The simplest form of physical flexibility is space that is easy to subdivide or sublease. In buildings that offer such space, companies can take advantage of less-expensive long-term leases while adapting to changing circumstances by subleasing some of their space to others.
Entire buildings can be designed for flexibility. For instance, modular buildings can be quickly erected and converted from one use to another. “Shrink-wrapped” facilities, designed from the inside out, can be smaller because they do not have the pockets of surplus space that typically exist inside a one-size-fits-all box. This reduced footprint increases the number of potential uses on a parcel of land. In China, short-lived “disposable factories” offer flexibility in land use and capital deployment. The disposable building is not always suitable—both employee comfort and environmental impacts must be considered. But such structures are one-fourth the cost of a permanent plant, take only one-sixth of the time to build, are simple to operate and maintain, and can be quickly and inexpensively dismantled.
