Optimize Your Real Estate

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James Pitts

November 19, 2008

Real estate costs are typically the third or fourth largest expense item for businesses after personnel costs. In a tough economy, as business revenues decline, the fixed (ownership) or annually escalating costs (lease agreement) of real estate has an even larger impact on a company’s operations. A business may reduce headcount, but often cannot reduce real estate costs due to the contractual agreements made when business was still good. This can be an issue when real estate goes from being in the background to dominating the fortunes of the business.

Here in Atlanta, there has been a rapid increase in the amount of space available for sublease as businesses have sought to offload their real estate burden. Let’s assume that the business is paying $22 per square foot under its lease with two years remaining on the lease term. If the business is able to locate a sublessee who will pay $15 a square foot and then move to a smaller space with a lower rental rate – it may make sense economically.

The business must still pay the incremental seven-dollar a square foot due the landlord under the original lease agreement and the new rental amount to its new landlord. Hopefully real estate will no longer be the constraining factor and the business can once again focus on returning to profitability.

How do business owners optimize their real estate in tough times? There are several ways.

If looking for new space or downsizing, the business may find subleases that feature lower rents with free or reduced price furniture in prime locations. If committed to a lease with 12 to 24 months remaining, the business may be in a position to restructure its lease. This complex negotiation is best accomplished with help from a real estate advisor who brings experience and leverage to the negotiation.

For example, in return for committing early to renew the lease at the end of the term, the tenant may be able to lower its rental costs over the remainder of the term by giving back space or lowering its rental rate. The leverage is the owner’s debt on the building and the tenant’s willingness to vacate at the end of the lease term.

In a tight debt market, refinancing the building with a smaller cash flow makes each tenant rental dollar extremely important. The owner is not eager to seek new financing that may not be available, or if so, at less advantageous terms. If the business owns its real estate, it may not be feasible to refinance in today’s market. The business may consider renting a portion of the space out at below market rates in order to “monetize” its real estate investment. A sale-leaseback is not advisable due to the higher capitalization rate (lower price) the business would receive in a slow real estate market.

When leasing or purchasing space, remember that no one knows what business will be like in three to five years, so keep it short and flexible if possible.

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