The Downsizing of Corporate America
and How You Can Profit
Corporate America is scrambling to compete in a global economy. As CEOs in corporate board rooms refocus on the bottom line, they're looking hard at real estate. Instead of just another cost of doing business, corporate real estate is taking its place as the fifth critical resource-right up there with people, capital, technology, and information. Today's corporations need to know how to use their real estate in the most profitable way-and how to dispose of it when it is no longer profitable.
In this article, four corporate real estate executives discuss these issues from an insider's point of view. They challenge real estate service providers to understand the changing needs of corporate clients and to consider how they can provide solutions to today's corporate real estate problems. Their message is loud and clear: Corporate America is ready to form strategic alliances with service providers who can help them compete. Are you prepared?
Frank A. Robinson:
Providing Solutions, Not Just Space
Frank A. Robinson is director of corporate real estate and site services for Tandem Computers, Cupertino, California. He is responsible for facilities planning, real estate and property administration, project management, facilities operations, and site services. Tandem occupies more than 3.5 million square feet in 180 locations worldwide. Revenues for 1993 were $2 billion. Robinson has more than 15 years' experience in managing corporate real estate assets and is currently president of the International Development Research Council (IDRC). Robinson earned his BA in business from Roanoke College and his executive MBA from Tuck Business School at Dartmouth.
Remember the 1970s and 1980s? Those were the days. At Tandem we were doubling in size every year. The big challenge was keeping up the revenue and head-count growth by providing enough space. The corporate motto was "bring me more space." Then came the middle '80s, with mergers and acquisitions, and now the '90s with downsizing, rightsizing, always trying to avoid capsizing. Today the motto is "less space is better" or "please take my space!" What happened? What are some of the factors that caused this shift?
The first factor is global competition. To compete in the computer industry today, we had to reexamine both our pricing and expense structures. Competing globally means the prices of our products are coming down. If we don't lower our overhead expenses at the same rate, we will have an economic problem.
The second factor is that jobs are being redefined. Today, people are doing their jobs differently than five or 10 years ago. At Tandem, for example, our sales/service personnel spend more time at customer locations and less at the office. And when they are in the office, they need different and often less space.
A third factor is the focus on quality. In addition to meeting customer requirements, companies are focusing on continuously improving processes within the organization. Often, the result is a need for less space.
The emergence of new technologies is another factor fostering the change. Many employees today have lap-tops, cellular phones, fax machines, e-mail, and voice mail that allow them to work more outside the traditional office. New technologies and processes are also reducing the need for warehouses and distribution centers. Some say the warehouse of the future will be on 18 wheels riding down the highway to the customers.
This is a different world we live in. Today, if senior management wants space at all, it wants it faster, cheaper, and more flexible. It wants to increase employee productivity.
How is corporate real estate responding? First, we are reducing costs. Occupancy costs are typically the second largest expense for a company. Significant savings can result from corporate real estate programs that reduce the amount of space needed and reduce the total cost to operate the space. At Tandem, we have a goal to reduce worldwide occupancy expenses by 40% over three years.
Corporate real estate groups today must also operate on shorter facility delivery schedules. Most companies need to reduce "time to market" for their products. This is in direct conflict with typical real estate development time schedules, which in many cases exceed three to five years. Companies need new, quicker ways to deliver space so they can get products to market quickly.
We also need to provide more-adaptable space, to accommodate changing business climates and technology. We need to get the most efficiency out of our space as well as design it so that we can convert it quickly and at the lowest cost for the next business initiative.
In the end, corporations want less space. And the space that they do want will be work environments that are efficient, are inexpensive, allow for high employee productivity, and respond to the changing needs of the company. It will not all be traditional office space.
Another major change today is the downsizing of corporate real estate departments and the related shift in required skill sets. For example, at Tandem, the internal corporate real estate and site services group has decreased internal head count by more than 35% in the last few years. We are retaining those tasks and skills that are our core competencies and that have the greatest impact on the company's performance. We have been out-tasking the others. Our internal people skills are moving from doing the technical task to managing the process. They are integrators or orchestrators who set expirations, establish the teams, and track team performance against pre-established goals and objectives.
Often with downsizing comes the need for outsourcing or out-tasking. What can you do, as service providers, to fill the gap?
First, you need to listen to your corporate customers. This is a message that I can't drive home enough. You need to explore with your corporate real estate partner what changes are occurring and how the changes affect their need for your services. And you need to do it often. Make sure you know what the problem is before you bring a real estate solution to the table.
Second, you need to help the corporation make every dollar count, not just initially, but on an ongoing basis.
Third, you should learn more about the new "workplace environment alternatives"-what products and services will be needed in the future. For example, the advent of the "work anytime, anyplace" concept means that technology and connectivity (voice, data, and video) issues are important. These are skills that today's service providers rarely offer. Also, there is an emerging need for reliable, knowledgeable international real estate resources.
Fourth, it's important to assess your firms' strengths and weaknesses. There is a lot of competition out there today. What unique abilities differentiate your firm from other service providers and can make you the "best in the class?" And if you don't have all the necessary skills, do you add them internally or partner with another firm that has what you lack? Do you explore "preferred vendors" or strategic partnerships with corporations? You need to know what works, what doesn't, what's profitable, and what's not. What differentiates service providers today isn't their ability to perform technical tasks. It is the extent to which they can understand the basic problem and can provide creative and innovative solutions, and the extent to which they are willing to allow their performance to be measured.
Let me summarize what I am preaching. Yesterday, corporate real estate was just about space. Today, it's about providing workplace solutions to emerging business needs. Space is only part of the total solution and at times may be the wrong solution. In the long term, it will pay to take more time to understand what the business problem is and to show how your solution adds value to the company.
Things are changing dramatically in corporate America and corporate real estate. The good news is that along with these challenges, there are also lots of opportunities. Are you ready?
Closing the Gap
Ann Bamesberger is corporate real estate manager for Sun Microsystems, Palo Alto, California. Sun is a $4.5 billion company in the UNIX workstation marketplace with more than 5.3 million square feet of real estate worldwide. Bamesberger manages Sun's U.S. holdings of 3.9 million square feet. Her experience prior to Sun was primarily with Hewlett-Packard, where she held positions in real estate, operations, and marketing. Bamesberger has a BS/MS in civil engineering and an MBA, both from Stanford University. She is also the Northern California chairperson for IDRC.
In the arena of corporate real estate, I have observed a gap between senior management expectations and corporate real estate service delivery. To bridge that gap, we need to understand why it exists. Then I'll propose some ways to close that gap, because we all stand to benefit if we can accomplish this.
It's important to understand what senior management expects: it wants to emphasize customer service and marketing; it wants to meet business units' needs by focusing on return on assets (or other performance metrics); and it wants to get more involved in creating innovative work environments.
But we-inhouse and outside corporate service providers-have not been living up to those expectations. We tend to spend a lot of time being reactive, rather than being proactive with the client. Also, a lot of corporate real estate departments believe that if we can provide a centralized financial control function, we can make sure that we implement uniform standards and control mechanisms and we can provide all of the real estate processes in house. But, frankly, as business units become stronger and there's more of an effort to decentralize the financial control and profitability and loss of the business, there is less standardization and more customization in the marketplace.
In the past, managing status quo was a classic old-school way of doing business-just keeping facilities operating, as long as no one was complaining. That isn't true anymore. For example, while old-school service providers are focusing on cost, senior management is now more interested in return on assets. And senior management wants to be at the leading edge of creating innovative work environments, which could also potentially be a way of enhancing the company's competitive advantage. Status quo thinking won't accomplish these things.
In terms of closing the gap between senior management and corporate real estate providers, the two best places for us to refocus our skills are 1) customer service (meeting business units' needs) and 2) the return on assets in the business unit environment.
When I talk about customer service, total quality control concepts come to mind. There is wisdom in the talk about quality programs, particularly the concept behind continuous improvement. TQC is not the quickest way to make a deal, but it certainly is an investment in the learning process that will make better deals in the future. This is not comparing dollars per square foot; rather, it is comparing the processes for achieving the best product in its class.
Another helpful tool is best practices benchmarking-a process of comparing a company's or business unit's results, methods, processes, and practices against other companies or business units and determining which "best practices" should be integrated into the organization. We are working with our competitors to figure out what some measures for "goodness" might be in the future so that we stay ahead of the game.
We also need to do a customer satisfaction survey every now and then. Surveys have tremendous value in terms of communicating. They are a way to demonstrate to senior management that customers are happy.
Finally, combining internal and external resources is essential. We don't believe our internal corporate competitive advantage is the same as yours as an outside service provider. Our skills should complement each other: we should be the business-content experts of our company's industry and you should be subject-matter expertsin your business (real estate advisory, demographics, facilities, and others). Together we have a mission to satisfy business units' needs. As soon as an outside service provider has a message that is marketable to the business unit, the door should be open to suggest it and discuss it.
Besides customer service, the other major component in closing the gap is to focus on return on assets and innovative work environments. First, we need to figure out what we can do differently to get the best return on our company's assets-and to influence the company's competitive advantage. That's not easy, especially when our company makes computers and the connection between real estate and making a smarter, faster computer is not obvious.
We also need to focus on future work environments. With alternative home settings and virtual offices, there is an opportunity for the computer industry to get involved in the physical environment. Technology is the enabler.
Third, we need to seek new metrics, or measurements, of real estate portfolio performance. The cost of real estate is not the only element in the decision-making process. The portfolio must be flexible, and the space must enhance worker productivity. The human resource is still the crown jewel of most corporations. We work in "communities" of shared goals and responsibilities and we need to understand how these communities convene in time and space. We need to determine what the metrics of performance will be in the future-how to measure productivity in the workplace and what the physical environment does to influence that. We need to be able to use and build on this information.
Fourth, it's important that we collaborate with other functions, mainly human resources and information resources. These days those two functions in real estate are blended. To talk about infrastructure without talking about the potential of communications and information networks would be naive. To ignore quality of life issues from the employee standpoint would also be naive. The collaboration in terms of making real estate more of a systems integration function is a trend.
Last, another significant trend is the notion of continuous learning. This is an investment in the learning process, not merely driving for a result. Learning occurs when there is an opportunity to experiment and improve on processes.
In addition to skills, closing the gap also requires the ability of corporate inhouse staff to form strategic alliances with outside service providers. For us to succeed at forming these strategic alliances, we need to understand and appreciate each other's skills and perspective. We need to view each other as extensions of each other's staff.
In this process, the expectation of trust is key. If I am going to have you talk directly to my business unit, I'd better be sure you say the same thing I would say and that we can represent each other. We ought not be competing.
As an outside service provider, you need to have a long-term outlook; just getting the deal done is a quick fix that we don't get anything out of in the long run. We're more interested in establishing long-term partnerships where trust can develop over time. We're also getting the outside service provider more involved in the intent behind the acquisitions and dispositions, because sharing common goals is a successful way to do business. Business units have goals. If you understand their goals and they understand yours, you are all speaking the same language.
Being excellent at delivering the core services is critical. People will pay for proven added value for all kinds of services. I don't want to hear somebody say they can do the job when I know they can't. And it will be important to understand enough about your abilities so that you know when to call in the other guy who can provide service in that area.
Try to be motivated by the process and the result, not just the result. The deal is important, but there is no beginning or end to a process. Try to appreciate the continuous learning, the investment in the process, and the time it takes. Every transaction is different, but continuous learning comes from the replication of process-with constant enhancements and improvements over time. Institutions have a way of doing business and it takes time.
Finally, think about doing the wise thing, not just the right thing. It's long-term thinking; it's an investment in learning. This requires more than just a shifting of skills; it's a shift in style. If you can make this shift in thinking and in style, you will be better equipped and able to compete in the corporate environment.
James G. "Skip" Law:
Creating a Surplus Property REIT
James G. "Skip" Law is vice president of corporate real estate for McKesson Corporation, San Francisco, a leading distributor of pharmaceuticals and non-durable consumer products. He is responsible for management of the company's 12.5 million square feet of real estate worldwide and is responsible for creating a surplus corporate property REIT for McKesson. Law is a past president of the International Development Research Council.
Since the late 1980s, the trend of downsizing has placed an unprecedented amount of excess corporate real estate onto the market. Sellers are abundant and purchasers are scarce. Our company, like many others, had excess real estate and was trying to come up with a more aggressive strategy to dispose of it. We wanted to go beyond putting a "for sale" sign on a building and continuing to reduce the price.
In order to solve this problem, we decided to create a real estate investment trust (REIT) that comprised surplus corporate properties from our company as well as other companies. This concept attempts to do business a little differently. It takes those traditional corporate real estate tasks and skills (buying, selling, leasing) and combines them with elements of real estate securitization.
The objective of this private REIT is to take an unused or underutilized asset off the balance sheet, remove the company's obligation and liability for managing the property, and then, once the property is repositioned and the fund is taken to the public market, retain a significant portion of the total return on the asset. The company contributes a piece of surplus real estate to a third party who can aggressively employ additional capital and focused management skill; the property increases in value and at the same time frees up some working capital for the contributing company to employ in its core business. By putting the property into a private REIT instead of selling it at a deep discount in today's depressed market, the company maintains an equity position in the property and therefore retains the upside potential when the REIT goes public and the shares increase their liquidity.
This is a particularly useful strategy for companies that have downsized and find themselves using some of their buildings at a 30% to 50% capacity. Most companies don't want to spend money to consolidate and then invest further capital to retenant the vacant space, because they have little assurance that the building will be leased in any reasonable period or that it will be sold in a vacant condition. So they continue to operate these partially vacant facilities in an efficient manner. This surplus property REIT allows the company to sell the building while the company continues to partially lease and occupy it, without having to write a long-term bondable lease for the whole property in the manner that an institution would require a conventional sale-leaseback transaction.
The REIT transactions are structured so that the properties are contributed at book value or half of market value, whichever is less. The contributing company receives 30% in cash and the balance in shares of the private REIT's stock. The corporation commits to providing a 10% return on the 30% equity portion of the sale until a new tenant leases the building and thereby terminates that obligation. This allows the corporation to continue occupying part of the building and only pay for the portion they are using, or to relocate without the burden of disposal and/or retenanting after they leave.
If the property's book value is at or below its true market value, the transfer of the property into the REIT can be structured as a non-taxable event. The corporation can then take these private REIT shares and apply them toward its annual accrual obligation dictated by the FAS106 regulation. This Financial Accounting Standards regulation requires companies to annually set aside the money required to meet their future financial obligations toward the health benefits of their retirees. This obligation was mandated more than two years ago and as of March 1993, all corporations with these benefit obligations have had to make this accounting accrual adjustment in order to comply with the standard. In some corporations, these initial corporate accrual adjustments have reached the billions and the continuing annual contributions are in the millions. Contributing these REIT shares in most instances is not going to totally fulfill this obligation, but it can partially offset it while at the same time improving the balance sheet and removing the obligation to manage vacant properties.
The corporations that are the primary contributors to the REIT will each have one member on the advisory board that will meet annually to assess the performance of the properties and the fund. The private REIT will be evaluated periodically to determine the best timing of a public offering. Taking the REIT public increases the liquidity and the valuation of the shares and makes them attractive to institutional investors.
This type of REIT creates opportunities for brokers. Surplus property REITs are another resource to which a broker can sell properties. Though corporate properties are the primary target, a property owned by an individual could qualify for contribution to the REIT under the same structured terms. The REIT gives an individual or corporation an immediate exit strategy while retaining a significant interest in the future improved value of the portfolio. The broker's skills can be used at several steps within this process, from the initial sale to the REIT, to the retenanting of the property after its renovation, to the eventual sale from the REIT to a third party.
The product profile of this portfolio is generic industrial buildings and some class B suburban office buildings-the kind of product that few others have high interest in presently. These properties must be located in high-growth markets with compelling demographics that suggest that there will be renewed demand within an 18- to 24-month period. With a careful selection of properties, a skillfully executed repositioning plan for each property, and steady improvement in the fund's overall cash flow, value can be created from this real estate that has become a burden to the corporations. And as the markets improve, corporations can share in the future benefits of a commingled restructured portfolio.
Dan Costello is executive vice president of the real estate division at Bank of America. He is responsible for the acquisition, construction, disposition, financing, and management of a $7-billion, 3,800-property real estate portfolio of the bank and its subsidiaries. He also serves as chairman of the board of Pacific Southwest Realty Co. He was formerly a senior vice president of corporate real estate/general services of American Express. He earned a BS from Purdue and has done graduate work in real estate law, financing, architecture, appraisal, and construction. He holds membership in Building Owners and Managers Association (BOMA), IDRC, International Association of Corporate Real Estate Executives (NACORE), and Urban Land Institute (ULI).
Recently AT&T announced that it was going to eliminate 14,000 jobs. At 200 square feet per person, that's 2.8 million square feet of office space being emptied somewhere. Multiply that by IBM, Ford, and others, and you'll see a major structural change called downsizing taking place in today's corporations. This change has a profound effect on the supply and demand for space and on the need for the services of real estate brokers, space planners, and contractors.
Bank of America's merger with Security Pacific-which is still in progress from a real estate point of view-serves as a case study to illustrate my point. It was the largest banking merger in history, and it significantly reduced space occupied. While it probably had a negative overall effect on the real estate industry, the merger process created opportunities for many real estate professionals to provide services to us as we implemented the process.
When we acquired Security Pacific, we went through a due diligence process, to assure our shareholders that we were not paying too much. We had to evaluate the real estate we were acquiring from Security Pacific. We had to determine the value of owned properties, do environmental and engineering investigations, review and value all of the leases, and get the information into our database. Last but not least, we had to estimate the profit and loss effects of the whole process of acquisition and consolidation of facilities.
Once the due diligence was completed, we had to develop a consolidation and conversion strategy. One of the overall objectives of mergers is to acquire new revenue and customers, but reduce cost by eliminating job and real estate duplications. We eliminated about 20,000 jobs, but not 20,000 people because we have about 10% turnover every year, and we were also able to place many people in other positions.
Bank of America's portfolio in 1989-'91 was running about 28 million square feet. After the merger, that increased to 48 million square feet worldwide. The objective of our consolidation and conversion strategies-and we have achieved it-was to reduce that 48 million square feet to 36 million-a 25% reduction. For example, we consolidated three high-rise buildings in downtown Los Angeles into two, eliminating a million square feet of leased space.
Now, you wouldn't think we could have put three into two, but we did. We completely restacked and reprogrammed the buildings. This always increases efficiency because over time, corporate space is inefficiently used-people quit, people retire, an empty desk here and there-and it costs so much to recapture the space by restacking the building. But if you're going to reduce from three to two buildings anyway, you restack them, apply your corporate office space standards, and move the people from three 75%-occupied buildings into two fully occupied ones, then dispose of the excess building.
We went from 4,600 locations to 3,800 locations. We used brokers heavily to dispose of the 800 locations that became surplus.
Our occupancy expenses at Bank of America were holding level until the merger, when the combined expense of the two banks jumped to $813 million a year. As a result of the consolidations, we reduced that to $650 million a year, an annual savings of more than $163 million.
In the corporate real estate divisions, Bank of America had 160 people and Security Pacific had 240 for a total of 400. That was reduced to 230. Security Pacific was a corporate real estate division that needed to be outsourced.
Outsourcing is another popular buzzword that needs agreement on definition. In terms of operating a corporate real estate division, there are two extremes. One is to have a department with people who do all the work associated with real estate projects and portfolio management, rather than retraining outside professionals. The other extreme is to outsource all of the real estate management and work and have no internal corporate real estate department.
In my opinion, corporations that outsource their master real estate strategy, basic decision making, and direct relationships with their business units receiving the real estate product lose too much control. Business units tend to want better locations and space than they need, and part of our mission is to ensure that the lowest-cost, workable solution is developed and to keep occupancy expenses down. We reason with our business units all the time about the location and scope of a project. We usually convince them about those issues. But if you're an outsource real estate firm, chances are good that you aren't going to strongly argue with your client.
Between those two extremes are many variations, but I believe that a combination of the two, called "out-tasking," is the way to do it. We have always outsourced architecture, construction, detailed space planning, site searches, preliminary real estate negotiations, and day-to-day building management.
To use a football analogy, we believe that corporate real estate divisions should devise the game plan, select the players, and coach the game. Blocking and tackling should be outsourced to professional service providers.
Once again, mergers, acquisitions, and downsizing are going to continue. We're going to see theses trends exacerbate the oversupply of space in every market. And the process that corporations go through as they merge or downsize presents myriad opportunities for real estate brokers and other professionals.