Owning real estate Featured

8:00pm EDT August 26, 2007

Real estate has been the main instrument of creating, maintaining and transferring wealth for nobility and moneyed classes for centuries. In recent years, institutional investment managers have embraced real estate more than ever due to its appreciation and cash-flow potential. The asset class provides an excellent counter balance to stocks, bonds and other traditional investments.

“Fund managers are looking to increase their exposure to real estate, primarily because of the consistency of its cash flows and the perception that its value fluctuates less than other investment classes,” says Chris DecouflĂ©, senior vice president of capital markets for CB Richard Ellis, Inc.

Smart Business asked Decouflé a series of questions to explore how ownership of real estate can increase the value of a company:

Why is ownership of real estate so important?

Real estate often appreciates and can provide significant tax benefits and its value never goes to zero. While stocks have the downside of potentially hitting zero, real estate always has inherent value. If you look at the demographics of the U.S., you have a growing population with some interesting regional micro-trends. With a key component of value being the relationship of supply to demand, the old maxim ‘they’re not making any more of it’ holds true for real estate as an investment

Businesses can capitalize on real estate’s wealth-building characteristics by owning their own facilities. Over the long haul, most firms find that real estate ownership creates hidden shareholder value that can be overlooked until a capital event looms.

Does the size of the company matter?

No. Small businesses can often be the biggest beneficiaries of real estate ownership due to the relative illiquidity of their underlying businesses. For example, a small accounting firm has minimal enterprise value other than the price for which it could sell its client list. If this same firm invested in an office building, in 20 years the building likely would be worth far more than the firm’s client list.

How about large companies?

With many companies being acquired for their underlying real estate value (Toys ‘R’ Us, Albertsons, etc.), large companies are finding that their real estate holdings can make contributions to their bottom line. Enlightened companies are performing forensic real estate audits to identify value and create strategies for their real estate holdings. In many cases, shareholders can realize large windfalls by identifying and activating under-utilized or forgotten real estate assets. Like every other asset of a company, real estate should be reviewed to see if it is providing the best long-term return for shareholders.

Is enhancing the value the same as enhancing the cash flow?

No. Companies should first view real estate as a tool for creating long-term wealth. It is true that in certain situations real estate ownership can be more favorable than leasing on a cash-flow basis (especially on an after-tax basis). Nevertheless, in most situations, owning real estate will sap more cash flow than leasing. The largest cash outlay is generally the initial investment — typically no less than 20 percent. If the equity component is a barrier for a company, many institutions and private equity sources are available to furnish the equity for a preferred return, which could run anywhere from 9 percent to 15 percent in today’s market. Under this scenario, the owner and investor split the upside after an agreed-upon hold period.

How can real estate be a balance sheet tool?

When a company has a reasonable portfolio of real estate owned free and clear, it has a balance sheet tool that can be used to fund company initiatives, shareholder distributions and other company needs. The untapped equity in these assets can be tapped through sale, debt instrument, joint venture recapitalization strategies and other financial engineering. The level of sophistication and liquidity in today’s real estate market is unequaled. It is not an overstatement to say this may be one of the best times in history to be an owner of real estate — provided the underlying fundamentals of your asset are solid.

CHRIS DECOUFL⊃ is senior vice president of capital markets for CB Richard Ellis, Inc. Reach him at (404) 923-1224 or chris.decoufle@cbre.com.