CRE portfolio management fundamentals #1 property is not a sunk cost
As with other overhead charges, there is a belief, sometimes correct, that noth¬ing can be done to reduce property costs directly impacting profit and loss ac¬counts. Worse still, in many organisations, particularly the older traditional sectors with many owned assets, physical property is treated as a free good. The inclination is to take and hold onto whatsoever is available to support individual egos for future uncertainties. Economic rationing does not exist.
It does not take much business expe¬rience to know that property and workplace accommodation, whether owned or leased, has a cost, and next to the cost of personnel, property and occupancy costs are most often a corporation’s largest operational expense item. How these costs are calculated and what budget alloca¬tions prevail has a profound impact on the behaviour of business units.
Portfolio Cost Measurement
The procurement and management of prop¬erty requires significant investment, both in capital and on-going expenses. To remain competitive, a rationing mindset is essen¬tial. Portfolios can then be structured and managed to provide an optimum balance between cost minimisation, operational ef¬ficiency and maximising return on the com-pany’s investment.
Total cost of occupancy should be the ac¬commodation and portfolio cost parameter. This measure includes a range of cost types: rental and operating cost recoveries paid to landlords; capital use charges or notional market rent for owned assets; direct oper¬ating costs including energy, cleaning, and general maintenance; depreciating fit-out and project capital costs; amortisation for make-good costs at the end of a lease; and relocation costs, such as legal, moving and professional advice.
Overall portfolio performance measured consistently on this basis – and monitored against annual budgets against which variances are reported on a timely and regular basis – is the platform for portfolio performance management. But too often these portfolio costs are all rolled up into one overhead as part of the corporate overhead gross margin. Some of these costs, such as the opportunity costs of owning assets, are neglected. So business units are often inclined to grab as much as pos¬sible – after all, costs are spread across all business units evenly in the gross margin calculation. Any cost saving initiative by one unit is shared by all. Any extravagance by another unit is watered down across all units and there is no incentive for self-rationing the use of accommodation by the units. As a result, meaningful and effective portfolio management is impossible to implement.
Management accounting charge-back sys¬tems are resisted in many companies because of the cost of administration. This seems to be particularly relevant to property and ac¬commodation costs. However, with some financial analysis of potential saving with a rationing mind-set, it becomes quickly evident that it is not whether a company can afford to imple¬ment charge-backs, but rather whether it can afford not to.
The “user pays” principle across all busi¬ness units and all property costs is a great rationing tool. Property is now no longer a sunk cost, a fixed overhead cost or a free good. Business units suddenly become highly vigilant man¬aging their cost allocations – and keeping the real estate team members on their toes, challeng¬ing all costs debited directly back to their cost centre. And true portfolio management starts to take hold. This principle is becoming more and more prevalent in Government asset management initiatives under the Government Immovable Asset Management (GIAMA) legislation.
The charge-back system needs to be simple, transparent and robust – but flex¬ible. Simple rules are needed to govern the control, management and performance of the portfolio and associated costs.
With a rationing mind-set, hidden vacancies of unused and unallocated workspaces are quickly laid bare. The true quantity and cost of vacant and surplus properties across the whole company portfolio can now be identi¬fied and minimised. With a whole-of-com¬pany portfolio approach across all business units, these vacancies can be aggregated and surplus accommodation identified and dis¬posed of.
A key principle of the ‘user pays’ approach is that the risk and cost of vacant space stays with the business unit that requisitioned the space. When space is no longer required or is likely to become only partially occupied, the vacating business unit needs to have the con-fidence to contract the Corporate Real Estate group to dispose of the space. This may be by way of re-allo¬cation to another unit, disposal in the market or negotiated release from the landlord.
This is where flexibility is required. Sometimes it may be necessary to use some flexibility to encourage certain actions. To encourage a co-location by a unit to more expensive, longer term corporate space may mean that the true cost of occupancy is discounted to its prior cost levels. From a corporate viewpoint this strategy may re¬lease a surplus asset.
This ‘whole-of-company’ portfolio ap¬proach also enables lease expiry profiles across the portfolio to be maintained at an optimal basis. These profiles are to be pre¬pared and updated regularly across the whole portfolio and not just single business units. With this understanding, lease negotiation strategies can be prepared for all leases on a timely basis.
The whole-of-company strategic portfolio planning process needs to be linked to an¬nual business planning cycles. The key prin¬ciple of portfolio planning is ensuring that there is a regular and consistent user pays cost recovery management via the account¬ing system. This needs to include a capital use charge or market rental for owned assets. These costs can then be reported against the financial performance and projections of business units.
Regularly communicating with business units to identify changing needs and usage of property is essential – this helps identify any hidden vacancies and under-utilised ac¬commodation. But, once again, a flexible approach may be required to encourage business units to immediately release under-utilised space. Their inclination is to hold onto the space until they are released from the costs. Excess space can then be managed and marketed diligently and proactively.
Dave Owen CA(SA), BCom, Dip(ACC), is a member of Coronet Global and Fellow of the Institute of Directors.