Real estate is used by the professional investment community as a
means of diversifying a portfolio and as a hedge against other investment
types. Along with stocks and bonds, real
estate in the last 10 years has become the
favored alternative asset class for
investors.
“Fund managers are always looking to
increase their exposure to real estate,
because of the consistency of the cash
flow,” says Chris Decoufle, senior vice
president of capital needs for CB Richard
Ellis.
Smart Business asked Decoufle how
ownership of real estate can increase the
value of a company.
Why is ownership of real estate so important?
Over time, real estate has proven that it
is consistent and never goes to zero.
We’ve had other forms of investment
show their ability to get to zero, such as
companies collapsing, etc. Real estate,
even in a worst-case scenario, always has
an alternative use. It maintains its inherent value. Looking at the demographics of
the U.S., there is a direct relationship
between population and real estate. As
the population continues to grow, so will
the demand for real estate.
The trick is within the individual markets. The key is the specific market. From
a macro-perspective, the better the location the greater the demand for the real
estate, whether residential, medical or
retail/office.
Does the size of the company matter?
No. Professional fund managers are
always looking to expand their client’s
exposure to real estate. This applies to
small, medium and large companies.
Regardless of size, all companies should
look at real estate as one way to enhance the value of their company and portfolio.
Is enhancing the value the same as enhancing the cash flow?
Again, no. Owning real estate is going to
cost more than some forms of leasing,
primarily in terms of the equity required
to own real estate. Typically, you’ll need
to put down 20 percent in order to
acquire the facility whether an office,
industrial or medical building. There are
many sophisticated ways that capital
markets today cooperate with buyers.
Even without the equity component there
are opportunities to go with institutional,
semi-institutional or private entities that
could provide the necessary equity for a
preferred return. This could run anywhere from 9 percent to 15 percent in
today’s market. The question becomes
whether your business is willing to give
up that return as part of its internal hurl
rate. If you have a reasonable amount of
cash it is probably better to come up with
the equity on your own.
Is it cheaper to own or to lease?
We commonly face the issue of ongoing
expenses and the question of owning versus leasing. With owning comes the cost
of a mortgage, which is probably higher
than leasing costs. That is offset, however, by depreciation that can be written off.
The beauty of real estate is that as the
buyer you are more likely to get a reasonably good deal than the seller because if
you are prudent and take your time, you
are more likely to find that gem of real
estate others may have overlooked.
Furthermore, if you have some equity
going into the deal you can begin to pay
off the cost while the property appreciates in value. Ten years down the road,
one-third of the property’s cost will have
been paid off and the property itself will
have hopefully appreciated by the same
amount. If so, you’ve created a nice bit of
wealth.
Down the road, a reasonable portfolio
of real estate owned free and clear will
enable its owner to create a capitalization
event. Done through either selling or refinancing, the working capital generated
will be comfortably and fairly neutral to
your books. Adding debt to the real estate
creates a ‘free source of capital’ for the
owner without having to issue stock or
endanger his or her debt rating. It can be
a very powerful mechanism when used
correctly.
CHRIS DECOUFLE is senior vice president of capital needs for
CB Richard Ellis. Reach him at [email protected] or
(404) 923-1224.