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Value Management: Unlocking the Value of Corporate Real Estate-Al Beaudette Attentus Advisors

Al BeaudetteIntroduction
Unlocking the hidden value of corporate real estate assets is becoming a powerful vehicle to add value to a company’s balance sheet and to enhance their bottom line. Most corporations do not focus on nurturing the value of these assets until after the property has reached the end of its useful life, and has been slated for closure and disposition. But how do you know if you have received top dollar for these assets?

Savvy real estate managers often lament that, when they sell an asset, they have not fully maximized its value. Unfortunately, their limited staff cannot possibly spend the time, energy and financial resources necessary to unlock an asset’s optimal value. The result is costing them millions in lost disposition revenues each year.

Fortunately, a solution is now available to a corporate manager that allows them the ability to close this value gap. It is a process called Value Management. Value Management is a step-by-step program that properly positions a corporate real estate asset to capture this hidden value versus giving it away to the ultimate buyer.

There are four approaches to value that will generate substantially different values for a given real estate asset: Book Value, Appraised Value, Broker Opinion of Value and Opportunity Value. The first three methodologies have been used successfully by corporate real estate managers for many years. Unfortunately, they don’t adequately address the challenges of value creation for both problem real estate assets as well as highly prized ones that are now located in superb infill locations. Only Opportunity Value allows corporate managers the ability to maximize property value upon disposition.

Valuation Methodologies
Book Value is determined by studying the fully loaded depreciated cost for a given corporate real estate asset. This process usually involves Corporate Finance or Treasury to determine the exact book value of a given asset. In addition to the land and buildings, Furniture, Fixtures and Equipment (“FF&E”) may be a part of this value as well. Some of this equipment may be relocated to a new facility, thereby transferring portions of the book value. Other elements may be auctioned off, thereby adjusting the book value further.

In older manufacturing plants, there is another component that could significantly impact its book value -- the cost of environmental remediation. To determine this cost, Phase 1 and Phase 2 environmental studies need to be completed. As many companies are finding out, the possession of these reports may also trigger a requirement to book the potential liability on the company balance sheets; thereby adjusting book value once again.

Appraised Value is determined by a licensed real estate appraiser. Most corporations use an MAI appraisal to set a baseline level of expectations for the value of the asset.

The Appraiser typically uses three approaches to value, then concludes with a value recommendation that blends these values together to come up with an estimate of value for the property: 1) The Cost Approach to value begins by looking at the market value of the land plus the cost of the improvements, 2) The Market Approach involves selecting comparable properties that have recently been sold, and 3) The Investment Approach focuses on converting the net operating income into an estimated market value through a capitalization of that income stream.

Broker Opinion of Value (“BOV”) is a valuation that is provided by a licensed commercial real estate brokerage firm. This value usually represents the price for which they would be willing to list the property.

Like the appraisal, it is often supported by land and building sales comparables.

The BOV may take into consideration what the broker believes a buyer would do with the property, i.e. redevelopment, etc. Sometimes this value represents “an alignment of all the stars”, and may not accurately reflect the time, cost and risk associated with the repositioning of the property. In other cases, it may significantly underestimate the value that the property could generate.

Opportunity Value is the value that a sophisticated buyer would pay for the property in a condition that has removed and /or quantified all of the “unknowns” that a buyer would have to discover. Unknowns include elements like environmental risks, entitlement, zoning, permitting, demolition costs, infrastructure costs, development fees, construction costs and other traditional development skill sets and activities. Opportunity Value eliminates the risk that a buyer would normally need to take when acquiring a property. With these risks removed, the buyer would now be willing to pay a higher price for the property, and the corporate seller receives true market value for their asset.

Value Management
The process that allows the corporate client to capture Opportunity Value is called Value Management. Value Management offers corporate real estate owners the ability to view their real estate assets exactly as sophisticated buyers view them. The value generated is the result of a proactive process that allows the corporate seller the ability to access the same tools and resources as the potential property buyer. The result is that internal second-guessing disappears, and corporate sellers can rest assured that they didn’t leave money on the table.

Implementing Value Management within a corporation involves retaining individuals with key skill sets including governmental relations, planning, design, entitlement, construction, finance and development experience. Most corporations would find the internal retention of these skills sets cost prohibitive. But now there is another option. They can retain a firm that possesses these development skill sets and delivers them as a fee advisor. Required services can be made available for purchase on a menu basis. The set of development resources and skill sets become an extension of the corporate staff, and for a fee, allows the real estate managers the ability to position the asset the same way that a retail buyer would ultimately view the property.

Value Management thoroughly researches all of the options for a corporate real estate asset. It blends corporate objectives and potential buyer objectives with the needs of local government, the community and the market. Essentially, an excess corporate asset is planned as if the corporation were intending to develop or reposition the property themselves. The result is a process that allows the company to maximize the value of a property by designing an exit strategy that takes the risk out of the disposition process for the seller, and removes the risk for the buyer.

The Value Management process begins once an asset has either been declared surplus, or has been identified as a potential disposition candidate. Book values are collected, an appraisal is ordered, and often a BOV is also requested. Knowing these values is critical in determining the next steps.

It is not unusual to find a book value that is in excess of both the appraised value and the BOV. This discovery alone might trigger the implementation of the Value Management process. In order for the corporation to avoid taking a write down on the asset, the property will likely need to be worked and repositioned prior to exit. In other cases the book value may be low, the appraisal high, and the BOV higher still. This may trigger a different scenario, indicating that there may be additional value that can be unlocked and captured. The key is to determine how much value potentially exists and what will be required to deliver that value to the corporate bottom line.

The next step in the Value Management process is to undertake a thorough asset analysis. This begins with an extensive market evaluation. The evaluation studies the overall real estate market and explores likely product options for the property. This process will uncover unmet community needs, traffic and noise issues, and numerous other factors that impact the community and the ultimate development. Sophisticated financial models are developed highlighting the financial benefits of each option.

Another very important part of the Value Management process is the quantification of any environmental clean-up costs. Understanding how a project can be developed to minimize the cost of the environmental clean-up is critical. As an example, the highest and best use for a given property may turn out to be residential. But the cost of cleaning the property to residential standards may make the project economically unfeasible. However, properly positioning future structures on an environmentally challenged site could significantly minimize the environmental mitigation costs, allowing for a blend of uses that keep clean-up costs in line with proposed uses. The results of these activities ultimately affect the value of the real estate asset.

The value of a real estate asset is also directly related to what the community will allow you to develop on it. When a community was courting you as a tenant, the incentives were flowing. Now that you’re leaving, the welcome mat has been rolled up. What a corporation may think they have the right to do with their property, and what the community now thinks they have the right to expect, is often in conflict with one another. Furthermore, these desires may have no bearing on economic reality. It takes an expert to help navigate and negotiate the financial impact of each of these decisions on the future value of a property. By taking this step, the corporate manager can now assure a buyer as to what can be built on the property. A development agreement with the community takes the risk component out of the land, allowing the value gap to be closed.

Value Management places top flight development expertise in the camp of the corporate owner of real estate. This expertise can be retained on a fee basis or for a negotiated percentage of the value that the Value Manager creates for the underlying real estate asset. Once the value has been created, the property is typically disposed of through traditional brokerage channels.

Some companies do not have capital available for Value Management activities. Once an asset is slated for closure, corporate policy prohibits the expenditure of any dollars beyond normal decommissioning activities. In this case, they can partner with a Value Management company that will front the dollars often entirely at their own risk. A floor value is agreed upon and a participation formula is developed that kicks in over and above that threshold level. The Value Manager assumes all of the risk, and only gets paid if enhanced property value is delivered through the repositioning activities.

In other cases, a corporation may choose to participate in the entire redevelopment process. Under this approach, The Value Management firm could form a joint venture where the corporate client would contribute the agreed upon value of the real estate as equity into the venture. The Value Manager partner would bring the additional equity to the table, and assume the role of the development manager for the partnership.

Value Management is a win-win scenario for corporate real estate managers and all associated parties. It assures their internal corporate client that they are achieving a retail sales price when disposing of real estate assets, and a more reliable target date for the booking of the receivables. The brokers win because they are assured that a transaction will close on the property the first time. And finally, the buyer wins. The due diligence, environmental and entitlement risks have been removed from the transaction, allowing the buyer to focus on redeveloping the product to its highest economic return.

Alan J. Beaudette
2008 NAIOP Chairman of the Board

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