Renata Simril
After personnel, real estate costs are typically the greatest expense for public entities. If you’re a public entity, a broker who serves public entities or a real estate professional looking to enter into this broad sector, now is the time to maximize one of the most powerful tools in a public institution’s arsenal: the real estate portfolio.
State of the Market
During today’s challenging economy, public institutions — cities, counties, states, ports, airports, universities, hospitals and not-for-profits — are under greater pressure to maintain service levels even as their resources become increasingly limited. According to the National League of Cities, for example, U.S. cities in 2009 faced an estimated budget shortfall of nearly 3 percent of their general fund budget. Results from a 2010 survey of federal, state, city, county and other public sector leaders — the breakdown of respondents included city/municipal (39 percent), state (14 percent), federal (13 percent), county (11 percent), quasi-governmental (11 percent) and other entities (12 percent) — to gauge the impact of the recession on public sector budgets and programs, as well as to identify emerging challenges and opportunities, confirmed that government budgets are strained and public officials are looking deeper than ever for ways to do more with less, even as they face increasing pressure to implement new mandates such as maximizing energy efficiency. It also revealed that 65 percent of respondents anticipate reduced budgets in the next fiscal year, and more than 17 percent expect their budgets to decline by more than 10 percent. These contractions are largely due to an economic recession that has reduced business, income and sales taxes, which fund many government activities.
The City of Ontario, located in Southern California just 35 miles from Los Angeles, early on recognized the need to reduce expenses in anticipation of declining revenues. With a broad look over a multitude of years and not simply reactionary steps made in short-term increments, the city implemented a comprehensive financial strategy combining the use of certain fund reserves; new revenue sources that had been recently developed; temporary reduction in internal service fund transfers; and personnel and operating cost reduction measures. The goal was to not just ride out the economic downturn but to ensure there would not be a reduction in services noting a responsibility to the businesses, employees, individuals and families who make a commitment to invest in Ontario. The City of Ontario also analyzed its real estate, specifically its city hall. The city has been able to apply key strategies to create greater efficiencies and reduce their operating costs dramatically for the coming years.
Solutions
For most involved in the public sector, the coming year will signal a dual challenge of adjusting to reduced funding without sacrificing service levels to the communities they serve. While their challenges are free flowing, most agencies seem to be putting less focus on slashing entire programs, monetizing assets or cutting staff. Rather, they prefer to seek across-the-board opportunities to reduce program costs without sacrificing function. Enter the real estate portfolio and three key solutions that can help public institutions move toward recovery:
1. Leases
Many government entities have experienced massive budgetary reductions and fundamental changes in their staffing and space needs. With fewer employees and a goal for more efficient office models, they’re looking to reduce the number of office locations and right-size their portfolio to achieve cost savings in as many areas as possible. Savvy public institutions — and their brokers — are using this landmark shift as an opportunity to critically analyze portfolios and make massive changes. If you’re not on this track, consider the following:
• Are you or your public institution clients paying above-market rents on a significant percentage of leases?
• Do you or your public institution clients have considerable square footage under multiple leases? Common expiration dates and common lessors? If so, can you leverage this for rent reductions?
• Do you or your public institution clients have a sizeable number of leases that could be consolidated?
If so, you’re the perfect candidate for proactive occupancy strategies that can significantly improve your balance sheet. Don’t forget: we’re in a near-unprecedented occupier’s market for leased office space, where many landlords are offering generous concessions to assure continuous occupancy. Use that to your advantage!
2. Dispositions
To raise operating capital, public entities must find creative ways to put non-essential, under-utilized and non-performing assets to work, while meeting program objectives. In the private sector, it’s common practice for firms to liquidate excess real estate and redeploy capital to areas of businesses where needed. Public institutions could benefit from employing these best practices as well. However, for public institutions to achieve maximum value on the sale of underutilized or unused assets, they should first look to employ the following:
• A strategic building/land-sale process and valuation model. This plan should include a comprehensive list of properties with relevant market data, including comparable sales/value data on like properties. Other key strategies, such as an aggressive market strategy and controlled bid process to quality potential buyers, will ensure that maximum sale value is achieved.
• A “highest and best use” analysis for vacant or underutilized land. This provides agencies with a greater understanding of any upside potential that a land holding might realize by entitling the site prior to disposition. Before engaging is such a plan, however, public entities should develop comprehensive market research, master planning, financial analysis, strategy development and implementation service for the excess land. Developing and evaluating these functions through the lens of private-sector investors and developers will further help public entities realize optimal values.
It should be noted that the best disposition strategy might be a public-private partnership. In this scenario, a public entity partners with the private sector in a ground lease/revenue-share arrangement. The strategy often results in an ongoing annuity of ground lease revenue payments to the public body as opposed to a one-time cash infusion.
3. Monetization/Financing
With rising costs and declining revenues, the monetization of real estate as a means to free up cash and/or take debt off the balance sheet is a strategy that is gaining momentum nationally, particularly with universities. Monetization includes a diverse range of financing strategies that enable public institutions to extract lump sums of cash from otherwise illiquid, revenue-generating properties.
• Debt restructuring, whether through monetization or more traditional approaches.
• Sale/leaseback transactions for properties that an agency intends to occupy for a long time.
• More intricate, yet rewarding, arrangements such as Enhanced-Use Leasing, a federal program for monetizing unused or underused public portfolio assets that solves the dilemma is unique to the federal entities — being able to retain revenue to your particular department versus sales proceeds going into an agency pool.
Retain Experts
Commercial real estate is a very complex industry and very few have the knowledge to help public institutions achieve their goals. So while it’s critical for agencies to understand these strategies, it’s even more important to ensure you have the correct team in place to implement those strategies. The combined effort of supportive internal public staff and an experienced commercial real estate advisor working together to put portfolios to their highest and best use, is a tremendously powerful tool in today’s economy. Unsure of how to select the right advisor? Consider the following:
• Does the advisor understand the politics, complex laws, regulations and policies that affect government real estate?
• Does the advisor have the track record of producing results for your industry?
• Does the advisor have expertise in portfolio analysis, brokerage, facility and project management? What about public-private partnerships, such as master planning, highest-and-best-use analysis or transit-oriented development?
• Does the advisor have a clear understanding of the public service nature of your business?
While engaging skilled third-party counsel and management may seem like it will cost additional funds, in reality it not only reduces costs and improves quality delivery, but enables executives and staff to shift their focus from day-to-day duties such as “putting out fires” to high-value strategic solutions with long-term payoff.
Final Word
Property decisions should never be made in a vacuum. A building or a parcel of land is nothing more than a resource for achieving a vision of where a public institution wants to go and how it intends to get there. There are numerous ways to deploy real estate assets. Having a plan that considers policies, systematic procedures and appropriate benchmarks, as well as identifying essential and non-essential properties is a critical first step. Government officials and other public entities should seek out public and private expertise to help develop these asset-management plans and engage third-party expertise to implement and measure results on their behalf. Ideally, these efforts make spotting under-performing resources reasoned rather than random. It can also provide an opportunity to recycle proceeds from asset sales into opportunities to meet threatened community and institutional goals and objectives. Real estate portfolio best practices have been implemented in the private sector, and public entities can evaluate using these proven tools to enhance programmatic objectives and achieve financial results in a constrained environment.
— Renata Simril is managing director, Public Institutions Group, at Jones Lang LaSalle