The Future of Real Estate: Going In-Depth with Roger Staubach
Five years into the new millennium, it's time to take a good look at the state-and the future-of real estate as it pertains to your corporate growth.
By Karim Khan
Our philosophy at Business Facilities is that for you to do your job of choosing a new location for your company, you need to have to tools to effectively manage the selection process. Managing that process is difficult, which is why many firms with the means to do so outsource it to another company. But even if you have lots of outside help, there's no replacement for educating yourself and those on your team about the fundamentals of location-hunting. While the rules of growing a business into new locations haven't been radically rewritten in the last 20 years, there have been important changes. We think it's time for us to review exactly what sort of knowledge you need to arm yourself with to make a good decision in 2005.
To find out more about the trends, best practices, and role of outside help in the world of real estate, we turned to an old friend, Roger Staubach, Chairman and CEO of The Staubach Company. The firm, formed in 1977, has become one of the leading go-to companies for companies that want to expand and want a lot of options presented to them in terms of location. The latest high-profile example of this is EADS North America (EADS is the majority owner of Airbus). The European aerospace giant will select a site in the United States later this year for its Military Modification and Assembly Line (which produces aerial refueling aircraft). The project is open to all 50 states, and EADS chose The Staubach Company to completely manage the process of screening the locations.
If it sounds like The Staubach Company is more than just a brokerage firm, it's because it is. Like several other major real estate firms around the nation and the world, Staubach goes beyond showing off pieces of property; it also advises clients about where to go and how to finance acquisitions. When asked to sum up for us the totality of what his company does, Roger says,
"The Staubach Company is a full service real estate advisory firm. We deliver cost-effective solutions for the users of office, industrial, and retail space. We have over 27 years of experience in strategic consulting, site selection, disposition, construction consulting, project management, real estate administration, portfolio management, financing, and capital solutions. We partner with our clients to understand their business and help them find the best real estate solutions. And if we haven't provided value in terms of time, money, and qualitative issues, we will waive part or all of our fees in excess of direct costs associated with the transaction. Our greatest value to our clients is market knowledge; and based on the volume of transactions we complete each year, we have become known as market experts."
The following is our complete interview with Roger Staubach.
Business Facilities: How would you describe the first five years of the new millennium in terms of the business of real estate? Are any new trends emerging, and have others faded away?
Roger Staubach: Companies are leveraging technology to improve their operations that can have an effect on their real estate needs. In addition, Sarbanes-Oxley reporting issues are making companies more accountable regarding documentation. With the downturn in the economy, the real estate industry has seen a huge decrease in demand creating large surpluses of space throughout the country, driving rents down, and creating attractive opportunities for tenants to secure good deals.
Based on current demand and rental growth, the industry seems to be at the bottom of the cycle. As we see sustained demand and growth, we anticipate rental rates will follow in the recovery process.
BF: What are your customers demanding today from you that perhaps our readers should be asking themselves? Are companies looking at real estate in new ways in terms of their balance sheets?
Staubach: Our clients are increasingly looking at the real estate assets they hold in a manner more consistent with the approach of institutional real estate owners--with a greater focus on asset value maximization--than the historical corporate real estate manner, which was to simply look at operational assets as part of a generic cost center or cost structure. For instance, the question is no longer, "Should I have real estate assets on my balance sheet?" Rather, it's, "Which assets should I own, and which assets should I lease?"
When one understands the market and asset lifecycle issues that would lead to an own/lease decision for each asset, one begins to understand the changing view of corporate real estate that focuses on both the operational effectiveness of an asset, and its long-term value characteristics.
In terms of new finance or ownership techniques, the most recent focus we see is using very traditional and accepted lease structures, with a strong emphasis on improving the efficiency of the capital structure behind the lease for the benefit of the corporate user. In these instances, the corporate user, or we as its service provider, seeks to put the equity and debt components together for its own real estate lease deals, from the most efficient sources, with its rent being a function of capital cost and facility cost, rather than with rent simply being an element of more general market circumstances.
BF: What do the smartest and most successful companies do with regard to their real estate strategy?
Staubach: They value their real estate as part of their broader business portfolio and they put it to work in a way that is optimal for their specific goals and objectives. They understand how to translate the strategic knowledge of their industry into an effective real estate strategy. (Of course, they also work with The Staubach Company!)
BF: Do you forecast any changes in the way companies have to be looking at their expansion or relocation strategies in the future?
Staubach: Yes. Firms will be more vigilant and sensitive to improved efficiencies and the ability to service their customers in ways that are important to them, such as shorter lead times, time-definite deliveries, continuous replenishment, and a host of other operating and service innovations. We are always asked by our clients how they can improve their distribution operations by either expanding or consolidating their facilities. The answer is always, "It depends on your objectives."
Many times, our clients will indicate that they have service issues with their key customers and that increased customer expectations and requirements are forcing them to do things that are cutting into their margins. Given that, cost and service are typically the key drivers behind the need to expand or relocate. The key change in ways companies look at their expansion and relocation strategies is that they will have to do it more often.
The greatest shift in expansion/ relocation strategies is happening in regional warehouse strategies. Similar to European strategies, there are several reasons why companies are using regional distribution strategies. With the onset of security and driver's hours-of-service regulations, firms are seeking to minimize their risks associated with disruptions caused by extreme distances and exacerbated by weather, driver shortages, labor disruptions, and potential terrorist threats. Further, demand for trucking capacity is at an all-time high. The need for competitively priced and high quality carriers are forcing the use of regional niche carriers, creating less reliance on national truckers. Manufacturers are also aligning with suppliers that are closer to their plants to reduce their inbound transportation costs. Responding efficiently and effectively to customer product complexity and service performance requirements is validating the use of regional, quick response warehouse networks.
This move is being validated on an almost weekly basis. In the 1980s and early 1990s, firms would review their manufacturing and warehouse network about every three years. Today, we are being asked to review their networks and facilities on an annual basis.
Peter Drucker, the guru of management, once said, "We live in a world that changes every 15 minutes." We also live in a world that requires companies to evaluate their plant and warehouse network yearly. As I already said, this change in fine-tuning facility networks is being driven by today's customer-driven economy. Customers have the upper hand, picking and choosing among a throng of competitors, who are many times burdened with excess capacity and offering similar products and services.
As productivity continues to increase faster than demand and products become ever-more like commodities, the days of easy growth are receding into the past. This is creating tailored distribution offerings to customers' particular needs, thus requiring a different and more responsive operating approach that changes year by year. Growth in today's economy is not mysterious, but it is difficult, because it demands new ways of thinking and operating. That's why companies are constantly looking for efficiencies and innovations in meeting their customers' needs while meeting their profit and growth targets in the face of tight trucking capacities, rising costs, and more and more government regulations.
BF: That sounds a little scary. What can our readers do to prepare themselves for this?
Staubach: We are being asked daily to review our clients' networks to determine where they locate their plants, warehouses, and offices. These questions emanate from all sorts of concerns; sales and volume growth, entry into new distribution channels, sales declines, rising cost, lower margins, degrading customer service, and a host of other issues.
We had a client that once said, "I want to know if we are doing anything stupid." Although that is a delicate question to answer, we did prove to the client that expanding into a regional distribution model versus his single distribution center approach was the solution to improving service and reducing cost. The improvement solution was able to decrease his overall operating cost, with major gains in service improvement. In the past two years, the company has achieved double digit sales growth with a similar rise in profits. The company is now asking us to review the opportunity and improvement potential of combining two of its operating units that serve the same markets with different brands.
My suggestion to readers is to formally review their facilities network, product flows, cost, margins, and customer service performance on an annual basis. Ask yourself, "How are we performing with our key customers or in our core markets, and are we better or worse than the previous years? Are we performing at our best, regardless of year-to-year performance?"
I would further suggest benchmarking yourself against firms outside of your industry, looking at what they do, why they do it, and how they perform on customer performance, growth, and costs as a percentage of sales. We are fortunate in the sense that we work with firms from all industries and have a 'birds eye' view of best-in-class performance. Of course, we would be willing to discuss and share with readers many of the insights we have gained over the years in dealing with all sorts of companies and industries.
BF: To change topics a bit, I'm wondering about all the talk surrounding corporate security and whether it's overblown. Is there a real need to focus on security in a way that hasn't existed before? If so, how does this affect the location and facility selection process?
Staubach: The simple answer is yes. Most firms do have security policies and procedures in place, but with the onset of The Department of Homeland Security, there have been several new guidelines and enforcement actions that are now part and parcel of daily operations. The key areas of concern are: procedural security, physical security, personnel security, education and training, access and checkpoint control, manifest procedures, conveyance security, and information systems and networks. Based on the above list, firms need to ask: "Are we compliant? What does compliance mean for our business? How do we leverage compliance into a competitive advantage?"
The answer to these questions comes from a comprehensive compliance assessment across the supply chain and against government regulations. Based on the assessment and specific industry, a road map can be developed. There are templates that can navigate firms through the maze of compliance requirements. Most of our clients are pretty much well down the path of what we call supply chain security since it is now a fact of life, as well as a key part of a competitive strategy.
BF: What do you see happening with transaction activity in the U.S. versus abroad? Where do you see that trend heading in the future?
Staubach: The competitive nature of business is forcing companies to expand overseas. According to the U.S. Chamber of Commerce, 42% of all companies with 100-500 employees are looking at expanding overseas or are already doing global work. Qualified low-cost labor and low-cost space, combined with the ease of doing business internationally compared to five to 10 years ago, is driving companies to take their business to where conditions are ripe. As a result, transaction activity is up on an aggregate basis worldwide. This trend should continue as the global marketplace continues to become more connected. We are being asked about Eastern Europe and China for manufacturing and India for call centers. General requests have also been coming in for South Africa; Central and Eastern Europe countries including Ukraine, Estonia, and Slovakia; as well as Morocco in Northern Africa.
BF: In terms of financing, how are companies choosing to finance transactions today, and what do you forecast in this regard for the future?
Staubach: Financing terms in today's markets are predominantly driven by the degree of corporate commitment desired for the asset in question--if an asset has a long-term operational requirement associated with it, and has strong long-term real estate market fundamentals, we are seeing choices made between corporate ownership (equity or corporate debt financed), and leasing, with a lease equation driven by corporate credit strength and long-term residual value.
For an asset with shorter term operational requirements associated with it, or for operational requirements that can readily be satisfied (with nominal frictional costs) in an alternative asset, the clear emphasis is on shorter term leasing, that transfers virtually all asset risk to the real estate owner. This really ties back to one of your earlier questions, because ownership/lease commitments, and the timing of operational requirements, certainly play a critical role in the equation that seeks to minimize the operational costs associated with real estate assets while maximizing the value of any capital committed to real estate.
BF: What about the volume of expansions and relocations you are a witness to? How much of a drop-off did you perceive as the economy soured, and to what degree has it bounced back?
Staubach: In 1999 and 2000 there was a huge demand surge. There was an equal, if not greater drop when the economy soured. Most markets across the country have suffered over the past couple of years with weak demand. This weak demand has also created great opportunities for tenants to leverage depressed rent conditions by restructuring their leases to reduce costs. The commercial real estate industry is experiencing a slow but steady recovery. As the economy continues to show positive growth, we will continue to see improvements in demand that will lead to increases in rental rates.
BF: In which areas of the country are you currently seeing the most investor interest and activity?
Staubach: Based on our analysis, southern California; Washington, DC; New York; and the Southeast are leading in the recovery process with the greatest improvements in local demand.
BF: Finally, what advice would you give to an executive undertaking his or her first major expansion project? In your experience, what precautions will lead to the best outcomes?
Staubach: While every project will have unique requirements, selecting an appropriate site always requires advanced planning. When selecting the location for a new distribution center, for example, the final decision can impact customer service, operating profitability, future growth, and employment potential. Proper planning can help streamline the process and maximize benefits. An unbiased expert on the team can provide objective analysis of current operations, identify challenges, suggest options for change, and prepare a benchmark for future comparisons.
In additional to providing an audit of the current situation, a consultant can also help management identify the essential criteria for the expansion and keep the team on-target throughout the macro and micro site selection process.
Questions or comments about this article? E-mail them to kkhan@group.com.
Our thanks to Roger Staubach, Frank Sherwood, Betty Johnson, and Beth Raeder at The Staubach Company for their help with this interview.
Did you enjoy this article? You also might be interested in Ernst & Young's Real Estate Prognostications 2005.
