Property is different- beware the unwitting!

Dependent on the allocation of roles and functions within an organisation, the responsibility of securing and managing property (no matter whether it is leased or owned) usually rests with the facility manager. It is probably trite to say property is different, but the unique features of property are often neglected in company decision-making processes. Problems tend to become major issues when these features are forgotten in the heat of the negotiations. This article explores these features and their implication in planning the strategy for a facilities portfolio.

DURABILITY

In essence, property and the buildings and structures constructed on it last for a long time, particularly if timely repairs and maintenance are carried out on a regular basis. But the durability of property can be both a positive and negative in strategic planning.

With owned property the durability is usually a distinct advantage providing not only an operating asset in which to conduct business, but also an asset that grows in value as an investment.

Many organisations and business units, however, have the incorrect belief that property is self-perpetuating. As result the required level of maintenance expenditure is neglected in budget planning and soon the durability of the buildings and structures is compromised.

Another implication of the durability of buildings as operating assets is the tendency to retain the status quo rather than explore new possibilities. Relocation is generally a major disruption and therefore businesses often remain in their legacy buildings long past their ‘use by’ date – after all the bricks and mortar are still standing. Often new modern production and office facilities will be far more efficient and effective in supporting enhanced productivity – more than justifying the cost of leasing or developing new facilities in more appropriate locations and the associated disruptions. For the owner/occupier a windfall property profit may even be realised where there is a higher and better use for the old properties.

The durability of buildings and associated long-term leases is also often the cause of companies neglecting their property decisions – tending to forget that even long leases have expiry dates. These catalyst dates for renegotiation or relocation usually arrive much quicker that expected and can catch management unprepared.

HETEROGENEITY

Every piece of property, whether freehold or leased, is different and even if these differences are only marginal, they can make the valuation and pricing of property problematic. The more heterogeneous or specialised the property, the more difficult it is to determine the value.

With appropriate strategic planning, one particular advantage of property is that it can be customised to suit specific needs. This planning needs to be done comprehensively at the commencement of the development cycle to clearly determine the specification and scope of the buildings and structures. Too often the scope and specification of new buildings evolve and change constantly during the development process and, while this adaptability is a very useful attribute of property, it can also become very expensive. Clearly detailed specification and scope prior to commencement of construction are essential to avoid sloppy decision-making and the tyranny of property heterogeneity – variations and ever increasing costs.

The specialised nature of a property can also have a negative financial impact when exiting a property. If it was owned and is to

be sold, it is unlikely that a new user will be found who can fully utilise the specialised components of the property. These are often the specialised components that may have been the most expensive to incorporate initially, providing a clear indication that the property has been over-capitalised in terms of market valuation parameters.

In leased premises, the tenant’s ‘make-good’ obligations at the termination of the lease is often a shock, particularly once the cost of undoing specialised fixtures, fittings and structural changes is calculated. In hindsight many tenants have revised thoughts about the wisdom of the inter-leading staircase or the executive washroom constructed at enormous expense. Were these really necessary and did the initial construction and ‘make-good’ costs really add value to the company during the duration of the lease?

LONG LEAD TIME

Negotiating new leases or constructing new buildings tend to have very long lead times, particularly if the preferred relocation alternative has to go through the development process. This is a long and tortuous process seldom understood by those not involved in the development industry. The complexities of building design, development approvals and the project delivery are most often totally underestimated in terms of the overall time required.

Planning for elapsed time in a successful relocation must allow for activities such as the needs determination, identifying alternatives negotiations, executive approvals, legal documentation, planning, fitout, actual relocation and even undertaking ‘make-good’ obligations. All this needs to be done within the remaining period of the lease – or else the landlord will be demanding payment or remedy as entitled in terms of the existing lease terms.

Continually monitoring critical lease dates and planning ahead very diligently to allow enough negotiating lead-time are essential responsibilities within the facilities portfolio planning and management process. The lack of remaining lease time will usually result in staying in existing premises and negotiating from a position of weakness, a soft lease renewal with an existing landlord.

HIGH TRANSACTION COSTS

Anyone who has been involved in property deals knows that leasing, buying and relocating have high costs attached. So the focus in strategic planning must be on doing it right and doing it seldom.

Property seems to attract a unique complexity of costs and duties, including stamp duties, legal fees, professional fees, moving costs and other similar imposts. One of the largest costs that is seldom adequately accounted for, however, is the cost of business disruption during the relocation process.

These costs are made worse if critical lease terms are not managed appropriately, and it soon becomes apparent that the most expensive part of property leases is coming to terms with an existing landlord when no alternative viable accommodation options are realistically available. Landlords thrive on negotiating from positions of strength, particularly with ill-prepared tenants.

IMMOBILITY

It is obvious that property has a fixed location. The location is immobile and fixed for the duration of the lease. This can be good or bad for business. The specific location of property and premises is probably the most critical for retailers. The monopoly of location dictates, for example, that the retailer situated on the prime retail corner will be more successful than competitive retailers situated around the corner. This is the reason that the owner of the corner shop property can dictate the highest rental, justified by greater pedestrian traffic and probable higher retail sales. But beware the unsuspecting retailer with an impending lease expiry who is unable to come to reasonable renewal terms with the premises landlord. Having to relocate to an alternative location will require the retailer to re-establish customer goodwill.

The other component of the immobility of property is the built structure. Construction technologies have evolved to permit limited mobility of these structures being able to be moved to a different location – this is of limited application and represents only a small portion of the overall cost of the facility. The original property location obviously remains unchanged.

BOTH A CONSUMER GOOD AND AN INVESTMENT GOOD

Property is unique in being both a consumer good as well as an investment good. For an owner/occupier, this usually does not present a problem, providing clear strategic planning objectives are defined. Some planning objectives are conflicting; for example, ‘lowest possible occupancy cost’ and ‘highest possible property investment return’ are alternatives and cannot both form part of an owned facility strategy plan.

In leasing and ongoing management negotiations between tenants and owners, it is essential to be aware of the conflicting objectives that exist between property as an operating asset and property as an investment asset. Some of these conflicting ‘ideal’ objectives are tabulated in Figure 1 for a clearer understanding the differences.

Obviously deals are negotiated and agreed and the terms tend to end up somewhere between these two sets of ‘ideal’ objectives. Despite the large chasm that appears to exist between the owner and the tenant objectives, these parties do have one thing in common – a commitment for the asset in question. Owners need tenants, and users need to lease suitable operating assets.

It is well worth noting, however, that during any negotiations the core business of property owners is ‘property’ with all the unique features – whilst tenants and users tend to only get acquainted with these peculiarities on the occasions of impending lease expiries. At these times the realisation that property is different needs to be assimilated rapidly, or once again the landlord will get the upper hand in any negotiated deal.

A more proactive response is to ensure that these unique features of property are factored into any strategic planning of facilities portfolios.