FTI Journal
FTI Journal | Critical Thinking at the Critical Time

Real Estate in M&A: Making the Right Move

The prospect of an increase in M&A activity means now is the time to establish the true value of your organization’s real estate portfolio. Whether it is a hidden asset or a huge liability, the following steps should help to clarify its role in your business.

imageAs confidence in the prospects of the global economy returns, many observers are predicting a steep increase in M&A activity for 2010. For multinational companies considering blockbuster transactions, top executives face the challenge of meeting shareholder expectations for returns and optimizing capital – all while carrying out their business plans with leaner resources than ever. It only makes sense, then, for companies to pursue every avenue possible to extract value from the business.

As one of the top three items on a balance sheet, real estate represents a significant corporate cost. However, as an investable asset class, it is also a source of liquidity and returns. A company’s strategy for real estate should integrate these very different objectives to unlock far greater enterprise value than just the cost of the underlying properties. CEOs and boards can use the window of potential M&A activity to maximize the contributions of their real estate portfolio to the corporate balance sheet.

In an M&A environment, owned and leased real estate can be both a hidden asset and a serious unexpected liability. A company’s real estate holdings can deliver long-term advantage, contribute to earnings, and impact the bottom line. Conversely, they can have a profound and adverse impact on its corporate debt-to-equity ratio, constraining a company’s ability to finance expansion and growth. CEOs and boards who welcome real estate to its proper place at the M&A table stand to unlock the full operational and investment value of their real estate portfolio.

Use Real Estate to Generate Enterprise Value in M&A

CEOs and boards need to demand that real estate is part of the M&A process from the beginning.

Executives often regard real estate as a place where they do business, not something that has an impact on the business. Prior to embarking on an M&A path, management needs to develop an accurate assessment of both the investment value of a real estate portfolio and its operational value to the organization. The most effective transition plans integrate real estate assets into both the immediate M&A objectives and a company’s long-term goals.

In many deals, real estate is lumped into discussions about procurement or shared services – functional considerations that don’t have a comparable impact on the merger or acquisition. In a typical transaction, real estate can be a remarkable catalyst for liquidity and an immediate source of cost reductions. In every circumstance, a company that understands its resources – in both its operations and real estate portfolios – and can recalibrate them quickly to drive value will be in the best position to navigate M&A successfully.

Ideally, an organization should consider the enterprise value of real estate on a systematic basis as part of its annual planning process. Unfortunately, many organizations review their real estate holdings only within a short window of leasehold expiration or when considering expansion.

While CFOs are well acquainted with detailed financial numbers for other parts of the business, many don’t know their company’s square foot costs or details of leasehold agreements. It often takes a major business event – M&A, sale or expansion – for corporations to devote the necessary energy to developing their real estate strategy. By aligning real estate with operating and financial goals, companies can monetize these assets to enhance bottom line results, generate new earnings and meet shareholder expectations.

Timing Is Essential

Companies that pursue M&A opportunities eventually face the challenge of conducting comprehensive due diligence on their real estate holdings. This review should take place during the early stages of M&A due diligence, so it is on a complementary track with the overall negotiation process for the transaction. Delays only increase the difficulty of realizing the full contribution of real estate to a merger’s success: if a team is called in too late, it won’t have the time or the resources to uncover issues that could affect the long-term prospects of a deal and how transaction costs are accounted for.

For example, executives at a leading global publishing company acquired operations in the UK but didn’t turn their sights to real estate until after the transaction had closed. A postmerger analysis identified several redundant properties in London between the merged companies that were being carried at significant expense – an immediate drag on earnings at a crucial time. Once the company identified the problem, it consolidated its operations, resulting in significantly lower occupancy costs and new cost savings from streamlined business processes.

Real Estate Should Be an Asset Decision in M&A

By placing real estate on the same level as other assets – human capital and technology, for example – in M&A discussions, companies can unlock the hidden economic and operational value of their combined holdings. Two technology companies that merged demonstrate the benefits of managing the integration process proactively. The corporate real estate teams from both companies developed an integration plan to develop portfolio strategies and organization management solutions as part of the merger platform. The plan included the following items:

  • cost savings and occupancy redundancy analysis;
  • benchmarking and best practices;
  • value creation and monetization strategies;
  • acquisition and disposition opportunities;
  • incentives and tax credit opportunities;
  • supply chain and logistics enhancement; and
  • reputation and brand enhancement.

As a result, the best of each company’s corporate real estate function and practices were integrated to support the merged company’s business plan. This move eliminated redundancy in the combined operations, monetized excess real estate, substantially reduced operating costs, and fostered integration of the two companies’ cultures. In this case, real estate was used effectively to create shareholder value, immediate bottom line results, employee enthusiasm for the merger, and greater flexibility for the merged entity going forward. As a further result, the company developed new market strategies that boosted its growth prospects.

Valuing Real Estate Assets

As executives approach M&A, they need to broaden their thinking about real estate to identify how these assets can best serve the company’s needs. It should be seen as an important contributing element in an organization’s drive to realign businesses, improve earnings, and create new revenues. By taking a comprehensive view – that is, looking beyond the current operational use of land and property – new opportunities may become more apparent.

One company, for example, acquired a 250-site gas station-convenience store portfolio not only for its current use, but also for the valuable redevelopment opportunities of locations in major metropolitan areas. Similarly, McDonald’s purchase of the Boston Market restaurant chain in 1999 was significantly influenced by the latter’s portfolio of prime real estate. As companies set their sights on achieving greater operational sustainability, real estate has a key role to play.

Calculate the Proper Value of Real Estate Assets

M&A provides an opportunity for companies to get their houses in order. One of the primary challenges in determining the intrinsic value of real estate holdings is gathering accurate information: companies use vastly different systems and databases to track these assets. Since many companies make decisions on real estate at the business unit level, where it is considered a cost center, assembling the comprehensive data needed to understand the portfolio’s value can be a painstaking process. However, without accurate due diligence and the subsequent valuation of assets, the buyer or seller is potentially leaving more than crumbs on the table. Once equipped with a credible and defensible valuation, a company can determine the fair-market investment value of real estate holdings at their optimal use and create strategies to align real estate with M&A objectives.

Devise a Comprehensive Real Estate Strategy

While it may seem to be stating the obvious, decision makers should ensure that their company has a strategy for its real estate holdings. When real estate is dealt with as part of the transition, leaders typically develop an 18-month plan.

An effective plan should seek to turn real estate into a competitive advantage.

However, real estate decisions should have far longer time horizons. In our experience, many companies take a decentralized approach to managing real estate decisions – a serious impediment to realizing any benefits at the organizational level. An effective plan should align with an organization’s business strategy, recognize the dynamics of a given industry, take corporate social responsibility efforts into account, and seek to turn real estate into a competitive advantage.

Align Real Estate Strategies With Business Objectives

Real estate, technology and human capital are the three largest items on a company’s balance sheet. While most companies have integrated the latter two components into their business strategy, real estate is routinely treated as an autonomous function – to the detriment of the organization and its bottom line. An effective real estate strategy should be aligned with the organization’s business goals and objectives.

Real estate has a key role to play in achieving greater operational sustainability.

One Fortune 100 multinational financial-services company undertook a global reengineering effort of its real estate holdings and operations. The goal was to realize targeted cost reductions in its overall portfolio and associated operations over a two-year time frame. Significantly, this initiative was part of the company’s integrated global strategy of improving operational and financial performance and reducing costs. The company created an organizational platform to ensure that the corporate real estate function was integrated with business unit operations to deliver more efficient and effective real estate services. As a result, the organization reduced operating costs by more than $65 million annually and outsourced noncore functionality. This process also enabled the company to shed excess real estate and monetize properties in a sale leaseback strategy that contributed more than $1 billion to the balance sheet.

Recognize the Dynamics of Your Industry

Understanding the specific demands that different industries place on real estate is vital to developing an effective strategy. Since consolidation decisions in postmerger integration are often made based on geographic or market factors, rather than on operational ones, the value of real estate assets can easily be overlooked. This inefficiency can be exacerbated in organizations where business units continue to make real estate decisions that are not integrated into an overall execution strategy.

There isn’t a “one-size-fits-all” approach to real-estate strategy across industries. Professional-services firms, on one hand, are often driven more by human capital concerns than other factors. As discussed above, a more flexible real estate function can accommodate evolving workforce management approaches. Banks, on the other hand, have particular consolidation issues: the dispersed nature of a financial institution’s corporate operations, branches, and data centers can result in a high level of redundancy in mergers. Institutions that align their real estate function with strategies for delivering banking services will ensure that a merger captures the full value of existing locations and meets consumer demand for retail-banking products.

Integrate Corporate Social Responsibility Efforts

Beyond the immediate financial impact of real estate decisions in M&A, executives should also be aware of other less obvious factors that can greatly affect brand and reputational value. As shareholders and the public look for greater corporate accountability, companies will face increasing public scrutiny on how they conduct business.

Specifically, executives should measure, monitor, and evaluate such factors as corporate social responsibility, carbon footprint and energy use, and sustainability programs. Moreover, the global market has largely erased geographic boundaries, and companies will need to comply with energy reporting and building standards that will be measured and regulated in these areas. By focusing on these issues now, companies have a unique opportunity to bolster their reputation and brand value by communicating the benefits of these efforts to consumers and shareholders alike. Companies can take advantage of tax credits for green building and energy reduction and also position themselves for global-trading opportunities in carbon credits and renewable energy certificates (RECs). With this approach, an organization can retain maximum financial flexibility while enhancing its brand, reputation, and earnings by considering these secondary effects.

A large automaker’s experience of dealing with a proposed plant closure illustrates the value of addressing such issues proactively. The company’s closure plan would eliminate approximately 5,000 jobs, and local and national labor unions expressed concerns about the quality of replacement jobs that could be created through redevelopment. The state would also lose significant tax revenue over a two-year time frame. The facility had environmental and structural issues that needed to be addressed. To reduce the impact of the plan, the company established a public-private partnership and worked with state authorities to explore redevelopment options for the site and create replacement jobs. The resulting plan recommended a mix of commercial, light-industrial, and retail uses, and the automaker and the state created financial incentives and job programs to attract development and quality jobs.

Understand the Indirect Benefits of Real Estate

A comprehensive approach to real estate decisions must include elements that have an indirect impact on the bottom line. When assessing prospective locations, companies should consider such factors as access to high-quality executives and specialty labor pools (such as scientists or technologists), housing, education, transportation hubs and infrastructure, and the business and political environment. (See “Indirect Benefits,” right.)

As companies take advantage of M&A opportunities to innovate, the corporate real estate function should retain flexibility and develop new approaches to space utilization. Innovative workplace strategies for offices, plants and other facilities can play a crucial role in creating a work environment that promotes productivity and contributes to the retention of valued employees. The real estate function can also use technology to enable practices such as hoteling, telecommuting, and teleconferencing, which can help significantly reduce occupancy and travel costs.

It can take a merger or acquisition to force companies to devote the appropriate resources to managing their real estate portfolio proactively. Executives would be wise, however, to determine the value of their real estate assets, devise a long-term strategy, and elevate the role of real estate in a merger at the earliest stages of the discussion. Beyond contributing to the success of a deal, such measures could also help secure a competitive advantage and make a profound impact on the entire organization’s bottom line.

Published April 2010

© Copyright 2010. The views expressed herein are those of the author and do not necessarily represent the views of FTI Consulting, Inc. or its other professionals.

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The views expressed in this article(s) are those of the author and not necessarily those of FTI Consulting, Inc., or its professionals.
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