A crack specialist property team is enlisted to realise revenue from surplus property assets. Rather than a pure sales spree, management is encouraged to maximise value strategically. The rolling meadows of the idea can turn into a serious mountain climb without a well conceived and implemented Surplus Asset Strategy (SAS).
For business owners, government agencies, transport and infrastructure providers the real property assets owned may not be being fully utilised as part of business operations. Entire parcels of land or portions of a site may be surplus to requirements. In turn, this can present opportunities to raise additional cash by strategic divestment and redevelopment.
There are two fundamental decisions to be made regarding permanently surplus property assets:
– What are they?
– How to get the most value when disposing them?
What are the surplus property assets?
A companies asset management strategy informs management as to the assets required to operate the business over the short, medium and long term. It converts the objectives of the business strategic plan via asset management policy into a high-level, long-term action plan for the asset portfolio – including real estate assets.
Each property within the portfolio should have its own tactical asset management plan in order to support operations. Asset management plans typically include lifecycle budgets for planned maintenance and capital replacement, look at the age and condition of properties, their ‘fitness for purpose’, book and market values and how they perform in relation to industry benchmarks and the overall asset portfolio.
Good asset management plans take a look at how efficient the real estate is being used to deliver business operations. They look at optimisation solutions to determine if and what real estate is surplus to current and forecast operational demand. This is especially important when the asset is being used in a complex manner. For example it is often fairly simple to know if you have too much office space – the unused floor space will be all too apparent, however it is much more difficult where the operation is complex like a manufacturing plant or the use is for public amenity.
The best optimisation solutions come from looking at how the business operates in regards to the underlying real estate in the context of the changing real estate market.
This level of analysis typically requires external specialist property advice to assist asset managers to determine how surplus or not a real estate asset really is.
Each business obviously uses the real estate it owns in different ways – as different as the business themselves. Determining if there is surplus real estate will typically involve many stakeholders within the business and they will provide conflicting view points because a change to the real estate asset base may affect their area of influence.
To illustrate, lets say an Australian timber company operates 10 yards in their national portfolio. The Sydney yard operates on 10,000m2 of land whereas the portfolio average is 8,000m2. On the face of it the asset manager believes there is potential to downsize the 10,000m2 yard to 8,000m2 without affecting current and forecast revenue.
Before the asset manager engages with real estate expertise to assist her decision she convenes all the internal stakeholders to present their views:
– The local general manager, says he cannot possibly reduce the site size, they have always been 10,000m2 and look how full the yard is. If we reduce the size of the yard, everyone will be falling over each other and we will not be able to stock enough product.
– The PR department say, this is not a good look to downsize – it will send a signal to our customers that we are somewhat withdrawing from the Sydney market, this could impact on our reputation nationally.
– The finance department are very interested in realising a site size reduction, according to them this will reduce operating expenses by 10%, and can realise much needed cash to help service nationwide expansion into the provincial towns. However, they caution that they need at achieve at least 20% of the Net Book Value upon sale, otherwise a write down will occur and affect their balance sheet.
– HQ marketing and demand analysts caution whilst the current asset management strategy supports asset optimisation they are currently working on a new product line that would ideally need 500 to 1,000m2 of additional space to each store.
– Floor staff advise there is no way you can do that as that will probably mean narrower isles and that would leave no room for forklifts. Some staff voice their concerns that they do not want to lose car parking at the rear of the site.
Even on something as simple as a timber yard reducing its footprint can raise a myriad of issues and internal anxieties that will need to be resolved. In businesses with complex operational requirements the potential issues can multiply exponentially.
Surplus asset decisions for entities delivering public services can solicit extreme viewpoints (think judges influencing court buildings and doctors on hospitals). Reaching a decision to optimise these real estate assets is all the more difficult with strong vested stakeholder influences and potential political interference.
Therefore, a clearly formed Surplus Asset Strategy with top level management buy-in, a robust governance structure and detailed clear decision making criteria, all upfront, is very important. If high level analysis has already been undertaken then a target range of expectation can further clarify and incentivise decisions moving forward – for example reduce real estate holdings by 20% and unlock $50M in capital whilst maintaining 95% existing operational performance.
It is important the project governance group specify the ‘rules of the game’ in advance of trying to implement the SAS. You do not want to have to bring a potential solution to top management to have it rebuked because it does meet an unforeseen business restriction – whether it is opinion or structural.
Going back to our timber yard asset manager….
With all the internal viewpoints in hand the asset manager digs deeper. She benchmarks the property against the Sydney wide peers and finds that the average size of similar timber yard operations with similar revenue and stock levels is 7,000m2. Visiting competing stores she finds timber packed 6 shelves high, compared to only 4 shelves high at her store.
This has the potential reduce at least 1,000m2 in her store and still provide room for some of the new product if it ever does eventuate. PR are happy that they can spin the reconfigured store as still being larger than the industry benchmark. The GM is happy as in order to achieve 6 pallets high, he gets to trade in smaller forklifts for the latest high reach modern models. Everyone agrees they need to retain parking.
Further property advice shows not only is the value of the land exceed the book value by a considerable amount (appeasing the accountants) but also there may be potential to realise air-rights over the car-park at the back, which adjoins a medium density residential street. This could effectively free up another 1,000m2 of surplus asset.
The asset manager has a strong case that there is a total 2,000m2 of surplus real estate and she believes she has met all the criteria pre-agreed in the SAS.
The surplus asset project governance board agrees. Now they ask
“What are you going to do with it?”
How to maximise value when disposing surplus real estate assets
There are three key outputs to a Surplus Asset Strategy that will inform disposal implementation:
1. Register of surplus assets (the pipeline)
2. Prioritisation
3. Disposal options
These three key outputs are inter-related and somewhat inform each other and therefore require an element of iterative analysis. Keeping as many variables constant as possible (through the SAS project governance board) once decisions have been made is critical to enable successful implementation.
1. The first key output of the SAS is a register or pipeline of all surplus real estate assets at a particular point in time. The point in time is critical, as in an ever changing business environment what is surplus today may not be surplus tomorrow, and what isn’t forecast to be surplus this year may end up being surplus next year.
In addition, just because a real estate asset is surplus, does not mean there is a viable opportunity yet to realise value for a whole plethora of reasons:
– Planning rules restricting subdivision
– Planning rules restricting alternative uses
– Site needs decontamination
– Not sufficient market demand (air-rights are a little different if our timber yard is on the outskirts of Tamworth, rather than inner Sydney)
– Can’t get access to the surplus real estate (landlocked)
– Book value higher than market value (help and a psychologist needed to tackle this one)
– Restrictions on what the asset can be eventually used for (prevalent in public sector, but also you may not want to give competitors any opportunities if they are a likely current buyer)
– Neighboring property or community issues
A good SAS structures a clear process to deal with changing asset issues over time and can be updated accordingly. You want to know when a business or market trigger makes disposal more or less attractive.
2. The second key output of the SAS is to prioritise. One practical way to rank the priority of assets for a large and complex organisation is to use a layered filter system. That is you take the total list of surplus assets and apply the most important filter first, and then the second most and so on. The assets that meet the most filters go to the top of the list. This can also be used for some businesses to help identify which real estate is surplus in the first place. Having the filters and their cut-off metrics pre-approved as part of the SAS governance is important.
As an example in the timber yard business the first filter may be the ‘condition of the property’ and the metric to measure against maybe ‘forecast maintenance liability greater than $50,000’. The second filter maybe ‘PR risk’ and the metric to measure against ‘High, Medium, Low’.
The priority ranking assigned to each surplus real estate asset will be informed by a number of factors (potential filters):
– Absolute realisable value potential (focus resource on the big prizes first)
– Forecast maintenance and operating liability (old, poorly maintained, expensive to run properties)
– Public relations risk
– Political risk
– Ease/cost/time to transform and move operations to enable surplus asset to be disposed
– Management resource liability (how much time will this asset take from senior management)
– Planning and consenting duration
– Market demand
– Disposal option risk
– Disposal option resources (human + capital) required
– Timing in relation to financial year
– Tax implications
The ranking may be supplemented with a probability of success rating as well to forecast a weighted average return on the surplus asset pipeline. Although the probability of being able to realise a return quickly, itself, is one of the prime factors pushing it up the priority list – the ‘low hanging fruit’ approach. Many businesses that have been asset stripped over time don’t have too many low hanging fruit left. Even so, improving real estate markets can create substantial new opportunities and grow new low hanging fruit .
3. The third output is the analysis of disposal options aiming to find that option that will yield maximum value. Typically it is a risk vs. reward equation and the most common options include:
– Sell as-is
– Improve and sell
– Redevelopment
Each of these should be considered against the base option for each surplus real estate asset. The base option can be ‘Do Nothing’ but even that must take account of the minimum actions the business will be ultimately forced to do if it continues to hold the asset. Most real estate assets require at least security and insurance. Even vacant land needs to be mowed, rates and taxes paid and depending on your jurisdiction you may still require public liability insurance (yes for the homeless guy who walks on site and trips and hurts his back!).
For some assets there may be contingent liabilities that need to be allowed for in the base case. These can include the potential ramifications from pending political, planning, code or court decisions. For example new building regulations that require you to upgrade existing structures to satisfy earthquake ratings or new fire codes. Or there could be changes to who becomes responsible for decontamination and land remediation, or possible heritage listings preventing some disposal options.
The base case can also carry public relations risk such as in holding onto a derelict asset that is blighting an area.
Sell as-is
To sell ‘as-is’ may be the most appropriate option where there is competing market demand for your surplus asset, few obstacles to selling and others are better placed (according to your risk profile) to undertake redevelopment or improvement into alternative uses. It also usually means the shortest time to realise cash.
This is a fairly easy option to evaluate, a valuer will give you an opinion of the sale price and then you let the real estate brokers at it.
In our timber yard example earlier, it may be as simple as taking the surplus real estate including ‘air-rights’ to the market by an agent. The sale agreement would be likely conditional on gaining subdivision consent, a satisfactory buy back provision for car parking and a settlement period long enough to give the timber yard time to reconfigure their operations.
Improve then sell
Of course if the property has liabilities then the buyer is going to take that into account and may tag their offer for purchase with many conditions. That leads us to the improve first then sell option. Improvement can take numerous forms depending on the level of risk and investment required.
Improvement can be viewed as:
– Removing uncertainty and liabilities to enable a smoother sale at the market based value, or
– Adding value while the asset is in your ownership, effectively taking risk on your investment to generate a profit. The profit representing the price difference between selling as-is and selling improved less any costs of improvement.
Improvement before selling techniques for real estate assets include:
– Obtain planning consents to change site to highest and best market use
– Repair property condition to a usable, leasable or livable standard
– Renovate existing property to a modern standard
– Attend to a neighboring property to clean up area
– Decontamination and land remediation
– Heritage de-listing
– Demolition of existing properties
The asset manager for our timber yard may decide to tidy up the boundaries and fence appropriately to make the for sale lot more appealing. In addition rather than selling with conditions they undertake subdivision and set up the appropriate body corporate/owners association for the car parking themselves.
Redevelopment
Redeveloping the property can potentially yield the highest return but can also involve the highest risk – especially if the redevelopment is into a use that the business is not familiar with. Redevelopment is a higher financial return option when the anticipated profit on a change in use exceeds the likely proceeds from sale or undertaking lesser improvements and selling.
Sales risk can be mitigated through pre-selling (or pre-leasing and pre-selling) the finished product before construction commences. Construction risk can be mitigated through tight contracts. Planning risks (time to achieve rezoning for example) is already somewhat mitigated in that you already own the surplus land so may have time on your side at a lower asset book value than a developer would of had to purchase at.
Redevelopment is not for the feint hearted, especially if development or speculative investment is not a current characteristic of the business.
There are multiple scenarios for any development project that will need to be analysed to test feasibility and find the best solution. The business will need to allocate sufficient expert resource to undertake this analysis and note that it is often an artistic skill more than a science project to achieve a successful development outcome.
Redevelopment can take a number of deal structures including:
– Business redevelops surplus asset at their own risk and sells finished product. For example our timber yard asset manager may hire a development manager to undertake all activities to create apartments for sale over the car parking lot. This may mean the business sets-up a separate development entity to isolate resource, collateral and risks.
– Business enters into a joint venture with a developer, typically with the land component forming the asset owners equity into the project. The business and developer share in the profit or loss and share funding risk.
– Business sells asset to developer with a profit share on completion arrangement in consideration for a lengthy conditional period for the developer to obtain planning consents.
Finding the correct development manager or development partner is paramount to success. That means a rigorous and thorough process to not only identify the talent required but also to ensure you will be comfortable working with the partner. That is important in redevelopment, as the only certainty is that there will be problems along the way.
Portfolio vs Individual Disposal
One final point to consider is whether there is additional value in packaging assets together for disposal versus disposing them individually. This will be a judgement call depending on the likely market demand for the disposed assets.
– If all the assets are highly specialised (like ex manufacturing plant sites) and only a few likely buyers then there may be greater value through selling the whole lot as one portfolio.
– If some assets have limited attractiveness to the market, and others are likely to generate real demand then combining into a single portfolio may enable you to dispose of all. However, whether they are bundled or separated each asset is likely to be addressed on its own merits and the price paid will be adjusted accordingly – No free lunch!
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With the register of identified surplus assets, ranked in priority and suitable options identified for disposal your Surplus Asset Strategy is ready to be implemented. Of course this article really only touches the foothills of the K2 style complexity many surplus asset strategies must work through.