Cost/utilization modeling: A tool for improving your bottom line
For many companies, real estate constitutes a large portion of the company’s assets, liabilities, expenses or perhaps all three.
Additionally, whether through organic growth, piece-meal acquisitions, or simply an intense focus on the company’s core business, the company may find itself with a hodge-podge collection of real estate holdings that has little financial, functional or operational alignment.
Indeed, many companies take an ad hoc, transaction-based approach to real estate planning that focuses on a specific lease, purchase, or sale, one transaction at a time. This typical transaction approach may result in an effective property lease, yet negatively impact the company’s bottom line because that particular transaction is not aligned with the overall company business strategy. The company needs a strategic real estate plan.
Corporate strategic planning is not a foreign concept to business, but a real estate strategic plan may be long overdue.
Real estate strategic planning should focus on the destination: minimizing real estate costs as a percent of a company’s revenue and aligning real estate assets with the company’s business strategy. A company that develops a strategic approach to real estate planning will likely reduce its real estate costs as a percent of revenue, improve its operating efficiency, and improve its competitive position.
One simple tool in real estate strategic planning is a workspace cost/utilization model. This model can be used to test whether the company’s real estate occupancy costs — current or anticipated — positively or negatively affect the company’s bottom line.
The cost/utilization model evaluates the dynamics between the company’s current and ideal real estate occupancy costs per employee, the occupancy utilization of a given workspace, and the cost of a given workspace.
A company can easily calculate its current occupancy cost per employee by dividing its real estate costs by the number of employees. The ideal occupancy cost per employee can be determined through other corporate planning processes, such as projections for company revenue and profit, employee costs, operating expenses, capital costs, IT and R&D expenditures, determining competitors’ current costs per employee, debt service requirements, and general corporate performance targets.
Variations in the current and ideal occupancy numbers can be plotted as curves. On the y-axis is the cost of the real estate space (e.g., $/SF). On the x-axis is the space utilization per employee (e.g., SF/employee).
The difference between these two cost curves is an inefficiency and thus an opportunity to reduce the company’s real estate cost. Any space cost/utilization option that is on or below the company’s specific ideal cost curve is an acceptable real estate decision option.
The following example will demonstrate the model.
A company has a current occupancy cost of $8,000 per employee and a strategic performance target with the ideal cost of $6,000 per employee. The company is evaluating various classes of real estate spaces ranging from $10/SF to $60/SF, at an occupancy density ranging from 100 SF/employee to 600 SF/employee. The graph below demonstrates these two curves.
Only those workspaces that are on or below the ideal curve ($6,000/SF) will satisfy the company’s workspace utilization performance target. Those spaces that are above the curve (including those in the current curve ($8,000/SF) negatively impact the company’s bottom line and should therefore be avoided, disposed of or redesigned.
The best approach is a comprehensive real estate strategic plan that incorporates the company’s business strategy and financial goals, the company’s current real estate operation, benchmarks of industry competitors, and the company’s specific real estate occupancy cost target.
Though a company may find itself with an assortment of real estate assets that were not necessarily acquired through such a strategic planning process, the cost/utilization model is a simple tool for evaluating whether the company’s real estate assets are in line with its overall corporate performance targets.
The cost/utilization model can be used both for evaluating current assets and for avoiding the negative financial impact that may result from acquiring a real estate asset that does not align with corporate goals.
This article was co-authored by Greg Fischer and Roger Owers. It is intended for general information only. It should not be construed as legal advice with respect to any particular situation. Readers should not act upon information contained in this article without first consulting their lawyer.
Greg Fischer brings over 35 years of experience developing strategic real estate and property management solutions to help clients align their real estate assets and costs with their business strategy and financial goals, to improve their bottom line.
Roger S. Owers is an attorney and commercial real estate agent. Roger holds a Ph.D. in civil engineering, is a registered professional civil engineer and is a licensed attorney. Roger focuses on non-traditional, complex, and hairy commercial real estate and land deals, including deals in Indian Country.