Owning real estate Featured

8:00pm EDT March 26, 2007
Real estate is used by the professional investment community as a means of diversifying a portfolio and as a hedge against other investment types. Along with stocks and bonds, real estate in the last 10 years has become the favored alternative asset class for investors.

“Fund managers are always looking to increase their exposure to real estate, because of the consistency of the cash flow,” says Chris Decoufle, senior vice president of capital needs for CB Richard Ellis.

Smart Business asked Decoufle how ownership of real estate can increase the value of a company.

Why is ownership of real estate so important?

Over time, real estate has proven that it is consistent and never goes to zero. We’ve had other forms of investment show their ability to get to zero, such as companies collapsing, etc. Real estate, even in a worst-case scenario, always has an alternative use. It maintains its inherent value. Looking at the demographics of the U.S., there is a direct relationship between population and real estate. As the population continues to grow, so will the demand for real estate.

The trick is within the individual markets. The key is the specific market. From a macro-perspective, the better the location the greater the demand for the real estate, whether residential, medical or retail/office.

Does the size of the company matter?

No. Professional fund managers are always looking to expand their client’s exposure to real estate. This applies to small, medium and large companies. Regardless of size, all companies should look at real estate as one way to enhance the value of their company and portfolio.

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

Again, no. Owning real estate is going to cost more than some forms of leasing, primarily in terms of the equity required to own real estate. Typically, you’ll need to put down 20 percent in order to acquire the facility whether an office, industrial or medical building. There are many sophisticated ways that capital markets today cooperate with buyers. Even without the equity component there are opportunities to go with institutional, semi-institutional or private entities that could provide the necessary equity for a preferred return. This could run anywhere from 9 percent to 15 percent in today’s market. The question becomes whether your business is willing to give up that return as part of its internal hurl rate. If you have a reasonable amount of cash it is probably better to come up with the equity on your own.

Is it cheaper to own or to lease?

We commonly face the issue of ongoing expenses and the question of owning versus leasing. With owning comes the cost of a mortgage, which is probably higher than leasing costs. That is offset, however, by depreciation that can be written off. The beauty of real estate is that as the buyer you are more likely to get a reasonably good deal than the seller because if you are prudent and take your time, you are more likely to find that gem of real estate others may have overlooked.

Furthermore, if you have some equity going into the deal you can begin to pay off the cost while the property appreciates in value. Ten years down the road, one-third of the property’s cost will have been paid off and the property itself will have hopefully appreciated by the same amount. If so, you’ve created a nice bit of wealth.

Down the road, a reasonable portfolio of real estate owned free and clear will enable its owner to create a capitalization event. Done through either selling or refinancing, the working capital generated will be comfortably and fairly neutral to your books. Adding debt to the real estate creates a ‘free source of capital’ for the owner without having to issue stock or endanger his or her debt rating. It can be a very powerful mechanism when used correctly.

CHRIS DECOUFLE is senior vice president of capital needs for CB Richard Ellis. Reach him at chris.decoufle@cbre.com or (404) 923-1224.