Finding Value In Less Obvious Places

NEW YORK CITY-For most companies, owning real estate is an operational necessity, not a strategic investment. Many operating companies manage their real estate portfolios well, but still they view them as a cost of executing their core business rather than as a strategic use of capital. For these businesses, there may be significant untapped value in these assets.

Exploring ways to unlock this value, either for reinvestment into the business or other uses, could have a highly positive impact on both efficient use of capital and market perception. This is particularly true in a market climate that eagerly rewards companies for finding smart ways to add value to their shareholders.

The most important thing to consider is how to structure a deal that will meet the operational needs of the business and improve value for shareholders. Below are five considerations that may serve as a guide for framing a strategy to unlock real estate value.

1. What are the business' real estate needs? It is important that companies consider their medium- to long-term real estate needs before monetizing their real estate assets. For businesses with a clear view of these needs, the analysis is pretty straightforward. Grocery store chains, for example, typically have their high-value stores in locations they should be able to commit to long-term.

For businesses undergoing significant operational or structural change, however, it may be less clear whether to commit to a majority of their portfolio on a long-term basis. But even for these, there may be significant value to extract from a number of properties that are core to the long-term success of their evolving businesses.

2. How long is the space needed? Generally speaking, the longer a business can commit to occupying the space it is selling (agreeing to a 15- to 20-year lease versus a five-year lease at the time of sale, for example) the more value it can generate from selling its assets. Of course, this has to be balanced with the operational needs of the business. If significant change is anticipated, a mix of longer- and shorter-term leases may make more sense.

3. How much operational flexibility is required? While real estate ownership offers full control, a properly structured portfolio deal can effectively replicate the level of control and flexibility many businesses need. In a portfolio transaction, the buyers will typically allow tenants to operate like owners of the properties they occupy, provided any physical changes do not negatively impact the value of the real estate. This is especially true for businesses that bring large portfolios to the market. Also, in structured deals, it is possible to include exit clauses and other mechanisms to deal with unexpected changes in business needs. Some of these can be expensive but are usually only a last resort if other negotiated alternatives fail.

4. If the choice is to sell, does it make sense to retain a stake? There are a variety of reasons why a seller may want to retain a stake in its portfolio. They may want to benefit from potential appreciation in the property's value, particularly if the company itself is struggling. They may want to secure the option to buy back the real estate in the future. The pricing, technical and accounting impacts need to be evaluated. Whatever the case may be, accounting treatment should never be the driver for a transaction designed to unlock value, even though it may influence the route a particular company chooses.

5. What to do when the landlord changes? Having a different landlord will most likely have little to no impact on the business. Still, certain safeguards can be written into the original sale agreement—and the leases, if necessary—to minimize disruptions. One option is the right to buy the property back at a market price. Another is restricting who the buyer can sell the property to–barring future sales to a competitor while the business is still using the space, for example. These are just a few high-level points to consider when building a strategy around unlocking value in real estate. Above all, it is important that commercial reasons be the primary drivers for weighing what approach to take. Beyond this, figuring out ongoing costs and how much cash can be raised can be pretty straightforward. The same goes for calculating potential returns from redeploying the cash into the core business and other uses. Technical matters such as credit ratings, loan covenants, tax and accounting all can be managed. As a final point, when a strategy has been chosen, marketing and PR should be woven into the process. These are often only an afterthought, but getting the messaging right will help ensure that the strategy receives the best possible market reaction.

Howard Roth is the global real estate leader and a partner in Ernst & Young LLP's Real Estate practice. Michael McNamara, a principal and the head of Real Estate Capital Markets, assisted in the authorship of this article. The views expressed herein are those of the author and do not necessarily reflect the views of Ernst & Young LLP, GlobeSt.com or Real Estate Forum.