Business, Profits and Strategy

Andrew B. Zezas, SIOR
Relationship Manager,
Strategist, President
(908) 245-5999 x11
andrew.zezas@realstrat.com

Planning for the Way Out, On the Way In!
A Discussion about Real Estate Exit Strategies

Name one of the most important components of your company's business plan. Now, name one of the most important components of your employment agreement. Did you name the same component both times? If you said "Exit Strategy" you were right on target!

Remember your childhood fairytales, when Hansel & Gretel left bread crumbs on the ground as they ventured deeper into the woods, so they could find their way out? Even they knew, on the way in, that they needed an exit strategy to get away from the big bad wolf!

How dangerous would it be if a high level executive had an employment agreement that did not address his or her rights and responsibilities when the employment relationship came to an end? It could be a financial catastrophe, and would probably result in both employer and employee making serious errors, and end-up in an extremely lengthy and costly legal battle.

Now think about your company's business plan. What if the plan only addressed making money, and did not give consideration to key employees leaving the company, shareholders cashing-in shares, how to run the company when unforeseen change occurs, and so on? Would investors see such a company as a viable and sustainable enterprise, and one that is worthy of their investment dollars? Would you? Not likely!

It's fair to say that an exit strategy can be one of the most critical components to the success of any business initiative. If that's true, then why do so many companies enter into real estate transactions focused only on the entry and the on-going operations, and not the exit? Why engage in a multi-million dollar commitment for many years, typically one of the single largest financial and legal obligations of most companies, without applying the same logic that executives apply to their own employment agreements?

Painful, But True!

Years ago, a group of sole practitioner doctors in northern New Jersey pooled their money to buy a medical office building. Each doctor invested $250,000 to purchase an equal share, set-up his or her office in the building, and began to see patients. With sixteen doctors investing equal dollar amounts, this was no small investment.

As the years went on most of the doctors did well. Those who did not do well eventually closed their offices. Other doctors retired, and some even passed away. One of the doctors was forced to take time away from his patients to coordinate the building's day-to-day property management needs, just to make sure the building didn't fall into disrepair, and was never compensated for his time.

When some of the doctors decided they'd had enough, they suggested that the group sell the building. Due to the mistrust that existed between some of the doctors, the fact that some doctors were not available, some had leased their offices to other doctors who had no ownership interests but demanded a voice in decisions, some doctors were deceased with their ownership interests having passed to various family members and other heirs, the remaining doctors could not build a consensus as to what they could do. No operating or partnership agreement existed between the doctors, so no exit agreement existed either.

This very wealthy and highly successful group of educated professionals had no formal ability to sell their interests, sell the building as a whole, or exit their nightmarish "investment". Some hired attorneys, and some just threw up their hands in disgust. And, nothing happened. To this day, each doctor laments about being able to "one day" extract his capital and himself from their undefined partnership.

Planning Makes Perfect!

An international pharmaceutical company with operations in Princeton, New Jersey planned to construct a large headquarters office building for its domestic pharmaceutical sales group. The company assumed that it would occupy the building for at least ten years. In working-up the pro forma for the new headquarters, the finance team asked the question "What will we do with the building after ten years?".

Assuming that the company would either sell or lease the building to others after it served its purpose, the finance and real estate teams assessed the profile of the local market. Since they could not predict what would occur in the local market ten years forward, they decided to design a building that would:

a) Provide adequate space for the company's immediate needs, as well as, its projected growth over the next ten years;

b) Include a flexible design capable of supporting the needs of medium- sized tenants in a multi-tenanted scenario, and;

c) Provide the capability to accommodate the requirements of a single occupant headquarters for companies in other industries.

Although fitting all of the above into one building seemed like a very tall order, what came out of the planning process was an attractive headquarters with an extremely functional and flexible design, able to accommodate multiple occupancy scenarios.

The building served the operational needs of its initial intended occupants, the domestic pharmaceutical group, for over ten years. The building is now on the market for sale, is being considered by investors and potential occupants alike due to its unique and flexible design, and is expected to command a very high price relative to competitive properties.

Why Doesn’t Everybody Do It?

So, why is it that most companies don't plan for their exit on the way into a real estate transaction? Could it be:

In a business environment where most companies are managed on a quarterly basis, that the lease expiration or the day when the building will likely be sold is just too many years away for current management to be concerned?
An inability to predict the future impact of supply and demand?
Too great a focus on up-front or annual occupancy costs?
That most real estate professionals don't adequately advise their clients to plan for the way out on the way in?

The term "exit strategy" doesn't just pertain to what happens when the lease or mortgage expires? A pre-defined exit strategy will serve to uncover opportunities to build flexibility into a company's real estate plan. Where an exit strategy creates real value is in its ability to provide for an earlier exit from the real estate in the event of sudden, unforeseen, or even calculated changes in a company's finances or operations.

Plan for Change!

As a result of unforeseen changes in their market, a client of ours recently called on us to dispose of their entire headquarters facility only a short time after we completed their $17 million, 11 year lease transaction. When we initially negotiated their lease, we secured terms that provided our client with multiple opportunities to secure a smooth and profitable exit throughout the lease term. As a direct result of those built-in flexibilities, when we disposed of their headquarters facility, we were able to recover ninety percent (90%) of our client's remaining financial obligations, with little cost to our client and while shifting none of the burden to their landlord.

Even at the Last Minute

As we came down the home stretch of a many months long negotiation of a 130,000 square foot transaction for a major financial services company, the President informed us that his company would not be able to agree to the ten year transaction that would provide them with an extremely low rent, considerable concessions, and a very high construction allowance provided by the landlord. He said that the company had only days before put in place a plan to possibly spin-off twenty-five percent of the company after the third year of the lease term. As a result, the President told us that the company would have to change its real estate plan and seek only a three year lease.

We explained to the President that under a three year lease his company would be burdened with extremely high occupancy costs and that no landlord would provide the concessions and construction allowance that the company required. We then advised the President of his company's ability to build into its original ten year transaction the flexibility to terminate a portion of the lease early in order to provide for a smooth exit of the portion of the company that they might spin-off. We explained that in this manner the company would enjoy the best of both worlds...a long term transaction that suited the company's financial and operational objectives, and maximum flexibility by virtue of an early termination right for a portion of their space. The President approved the newly structured deal, the company moved-in, and the employees enjoyed their brand new headquarters.

Oh! Three years later, they never did spin-off that business unit. Go figure!

The Punch Line

So, what's the punch line about real estate exit strategies? Plan your company's next real estate acquisition with multiple exit opportunities in mind, whether the transaction includes office space, distribution, manufacturing, research, data center, or any other type of real estate. Achieving this kind of flexibility may have an impact on the cost of the transaction, and not all landlords or mortgagees will be positive about agreeing to it. Weigh the costs and the risks. Because, in almost all cases, securing the ability to smoothly exit from real estate will cost your company considerably less than needing that ability and not having it.

Better said: Plan for the way out of your company’s next real estate transaction, on the way in!

Andrew B. Zezas, SIOR, is Relationship Manager, Strategist, and President & CEO of Real Estate Strategies Corporation, Publisher of "Business, Profits and Strategy", a monthly online publication read by thousands of business, financial, and real estate executives nationally, and, is the author of two new real estate books, The CFO's Guide to Understanding Corporate Real Estate Transactions and The CFO's Guide to Hiring the "Right" Real Estate Service Provider, both of which will be available shortly at www.thecfosguide.com.

Mr. Zezas is well-known for his ease and informative style of public speaking, and has given talks, presentations, and has lead educational programs for business, professional, government, and trade associations, including the Building Owners and Managers Association, American Management Association, the U.S. Postal Service, RealComm, Society of Industrial and Office Realtors (SIOR), and others. Andrew is National Chairman of the SIOR Tenant Representation Specialty Practice Board, and is a licensed real estate instructor in Texas and Indiana. He can be reached at 908 245 5999 or via email.

Real Estate Strategies Corporation, located in Kenilworth, New Jersey, and serving clients throughout the country, helps companies create and execute Business DRIVEN Real Estate Solutions...and Opportunities, faster and with less risk. Visit www.realstrat.com.

Read other business, real estate, and finance articles written by RealStrat's experts.

THIS WORK IS DESIGNED TO PROVIDE PRACTICAL AND USEFUL INFORMATION ON THE SUBJECT MATTER COVERED. HOWEVER, IT IS SOLD AND/OR PROVIDED WITH THE UNDERSTANDING THAT THE AUTHOR AND THE PUBLISHER ARE NOT ENGAGED IN RENDERING LEGAL, FINANCIAL, ACCOUNTING OR OTHER PROFESSIONAL ADVICE TO THE READER. IF LEGAL, FINANCIAL, ACCOUNTING OR OTHER PROFESSIONAL ADVICE IS REQUIRED, THE SERVICES OF A COMPETENT PROFESSIONAL SHOULD BE SOUGHT. THE AUTHOR AND THE PUBLISHER SPECIFICALLY AND EXPRESSLY DISCLAIM ANY LIABILITY THAT MAY BE INCURRED AS A RESULT OF THE USE OR APPLICATION OF THE INFORMATION THAT IS CONTAINED IN THIS WORK.