Chapter 23 | Corporate Real Estate Decision Making

Overview

The chapter discusses the factors corporations and firms evaluate when selecting their operating space, reveals faults in a commonly applied own-versus-lease analysis framework, and provides a corrected version of the analysis.

Summary

The location, size, and type of space preferred by users differs based on their needs. Operations that require a large distribution warehouse, for example, will look to minimize transportation costs and have efficient loading docks.  As a result, warehouses will generally be located near major highway interchanges.  Offices that serve suburban clientele will often locate in office parks, a convenient location for interfacing with other businesses.

Market conditions influence space usage.  For instance, when market vacancy is high and market rents are low, tenants can stock up on “discounted” space, growing into it over time.  By leasing space to house future expansion, a business can both capitalize on the cheap rents and improve their space quality.

Firms must decide whether to own or lease their space. The chapter walks students through the flawed traditional “own-versus-lease” analysis, noting how the model is incorrect in that it incorporates depreciation and operating costs but ignores the opportunity cost of capital committed to real estate ownership. The result of this analysis is generally that the firm should own its space.  A corrected analysis which incorporates the opportunity cost of capital is presented, and it reveals that the rental option is generally the better option. However, each corporate real estate decision depends on the returns of the firm’s core business, the nature of the specific real estate market, the type of real estate, and the firm’s income tax profile.

Students should realize that they are also the “CEO of themselves,” and that while they may perceive a future primary residence as an investment, a house first and foremost serves the function of providing safety and shelter.  If acquired with a mortgage, it will also provide the bonus of a tax shield from the interest payments.  While NPV analyses enable you to compare the value of owning versus renting a primary residence, all of the academic models ultimately fall short because the modeling constraints are unrealistic and there is no variable for “emotion,” which often plays into the homeownership decision in a significant way.

Question

This is the type of question you’ll be able to answer after studying the full chapter.

Should Douglas Co. lease or rent their new headquarters for the next 10 years? Douglas Co. is a multinational firm that provides consulting services to clients around the world. The company has a 12% expected return on its invested capital. Recently the firm has enjoyed an expansion in their clientele and is increasing their employee count. With growth in size, management feels that the firm needs to move into newer and bigger offices and is exploring options. Gil Ron, VP of Development, was recently approached by a local realtor, who presented him with prime office space for rent in downtown Miami, available for immediate occupancy. The space he proposes is a single-user Class A office building with all of the high-end amenities demanded by management. Gil felt that the space is suitable and decided to make the case at senior management’s next meeting. The details for the rental option are as follows:

Surprisingly, a few days after receiving the rental proposal, Gil was approached again regarding the same space, this time with an offer to purchase the space for $100 million. Intrigued by the idea, Gil decided to present management with both options at management’s next meeting. The details for the purchase option are as follows:

Should Gil recommend the own or rent option?

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Key Terms

To view the definition, click or press on the term. Repeat to hide the definition.

The difference between gross and net leasable footage.

Allows a company with an economic and tax ownership position to hide the ownership (and the accompanying debt) from shareholders.

Chapter Headings

  • What Type of Space Do I Need?
  • Where Should I Locate?
  • How Much Space Do I Need?
  • Should I Own or Rent?
  • Faulty Own Versus Rent Model
  • What Is The Problem?
  • Corrected Own Versus Rent Model
  • One Size Does Not Fit All
  • Propensity for Corporate Ownership of Real Estate
  • Synthetic Leases
  • For How Long Should I Lease?
  • The Corporation of You

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