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While there are many factors that impact the financial structure of a relocation/expansion project, location is always a foremost consideration.
As the process for making location decisions has become more complex over time, it’s not surprising that financial strategies to support location decisions have also become more sophisticated. At its most basic, real estate finance still comes down to two fundamental choices: lease or own. But these days the factors that go into making an optimal decision go far beyond the fundamental.
In deciding to lease or own an asset, a company must consider financial and non-financial criteria. Financial criteria include occupancy cost, financing cost, balance sheet impact, profit-and-loss cost impact, credit risk, impact on earnings per share, and return on capital. Which financial criteria are most important depends on the relative importance a company places on measures such as economic value added, net present value, debt-to-capital ratios, minimum impacts on GAAP income in the first year and over the planning horizon, and EBITDA interest coverage.
Non-financial criteria include the extent of a facility’s importance to core business activities; characteristics of the property that favor owning or leasing, such as replacement cost or specific improvements; occupancy factors such as the length of the commitment and the need to control the environment; timing issues; and market factors such as the asset’s value retention and the likely ease of disposition.
To help a company make an informed decision, a real estate financial consultant might devise a formula wherein various financial and non-financial criteria are given weightings based on their levels of importance to the company’s strategic goals, and then the relative costs of owning and leasing are calculated for each criteria to determine the best outcome.
The nature of the location has a significant impact on these calculations. As many executives recognize, location decisions typically involve competition for talent and a corporation’s ability to identify the right labor pool to match its long-term business goals and objectives. This labor equation can be looked at as a spectrum of options ranging from higher-density, higher-cost options on one end (Tier 1 urban centers) to lower-density, lower-cost options on the other end (Tier 3 and 4 small markets). Especially in a downwardly trending economy, companies should look at multiple location alternatives and ask the question, “Can we get an equally talented labor pool for less money by locating in a Tier 2, 3, or 4 market?”
Layered into the labor equation are also two other significant factors affecting the overall financial structure of the resulting real estate project: economic incentives and the flexibility of real estate options. A clear understanding of all of these factors will lead to a more informed, often smarter decision.
Eric Stavriotis is vice president of Strategic Consulting at Jones Lang LaSalle, a real estate services and money management firm with a portfolio of approximately 1.2 billion square feet worldwide.