Why Short-Term Thinking is Not a Prudent CRE Strategy

by CoyDavidson on January 15, 2011

Small & Medium Size Business Should Think More Like Big Companies when it comes to CRE

Emerging out of the recent economic downturn, small and medium-sized businesses (SMB’s) have been looking to shore up their financial positions in order to ensure they are well positioned to take advantage of economic recovery as it accelerates.

Most have avoided risk and reduced their leveraged position, with the objective of rebuilding liquidity before considering any growth plans. While concerns for another downturn linger, most believe the worst of the recession has passed, and that their current actions will put them on the road to future growth and success.

Big Business is taking advantage of the real estate markets.

Unless you have been under a rock or corporate real estate decisions are something for others to worry about in your organization, you are well aware that the most recent economic recession and it’s sluggish recovery has created opportunities for companies to take advantage of soft market conditions in the commercial real estate market and secure very attractive long-term deals for their core space needs.

In 2010, we began to see larger companies do just that, but when it comes to real estate small and medium sized businesses have been sitting primarily on the sidelines.

The challenge with real estate.

Real Estate decisions are relatively long-term in nature as most leases are a minimum of 3 years for small businesses with 5 to 15 being years more typical for mid-cap and larger companies. No matter whether the economy is in a recession or expansion the reason for this is three-fold:

  1. Longer-term commitments from the Landlord-Lender perspective increase the probability of meeting mortgage obligations and provide the necessary stability for the underwriting of real estate assets.
  2. Capital has to be invested by someone (Landlord or Tenant) to improve the physical space to meet the users’ needs and amortizing this required capital over shorter time frames is not as economically viable.
  3. Relocation is a huge disruption for most businesses and there is both economic and operational value in having facilities to operate your business secured for longer periods. While short-term leases can be renewed, options to extend are not always granted and if so typically at higher prices.

In practicality, securing longer term real estate commitments typically translates into lower costs.

Make Longer Term CRE Decisions and Incorporate Flexibility

Today’s volatile and more competitive global economy makes the 3 to 5 year business plan a challenging proposition. I understand the decision in uncertain economic times to mitigate risk with short-term lease commitments. Yet having survived the recession, many SMB owners and principals feel they are smarter about running their businesses today than they were prior to the recession. The recession caused them to make some tough decisions to ensure their business’ survival, but those choices have made their organizations stronger.

The approach of the large corporate user as we exit the recession and economic recovery takes hold has been to look for new efficiencies and secure space for their core business operations long-term while rental rates are lower and building owners offer attractive concessions at the bottom of the market cycle. Furthermore, as the real estate markets begin what is expected to be a relatively slow recovery at least for the next 12 months, the ability to expand or contract  the lease commitment further is structured into the transaction giving the user the ability to right size as business conditions dictate.

For the SMB user who only requires for example space in the 5,000 to 40,000 square foot range the same mindset can be applied and similar type transactions can be structured.

In the current economic environment, there is a tendency from smaller companies to take a wait and see attitude and sign short-term lease extensions. The SMB user may or may not be comfortable with a decision to secure future expansions space. However, you have survived the recession, think like a big company and re-evaluate workspace strategies and space utilization, looking for efficiencies and then secure your expected core space needs for the next 5-10 years, while it remains a tenant’s market. Today, the opportunity to use real estate as a competitive advantage going forward exists both financially and operationally.

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