Risk Management & The Corporate Real Estate Portfolio
In a global business economy, firms have a broad range of corporate real estate needs. During the past decade, multiple strategies and tactics have emerged in the corporate real estate community for meeting those needs. From a business strategy perspective, corporate real estate must serve needs beyond the simple one of shelter for the workforce and production process. Certain uses are strategic in that they allow access to externalities, embody the business strategy, or provide entrée to new markets. Other uses may be tactical, in that they arise from business activities of relatively short duration or provide an opportunity to pre-empt competitors. Still other corporate real estate uses can be considered “core” to the existence of the business enterprise. These might be special use properties or may be generic buildings that have become embodiments of the organisation’s culture.
We argue that a multi-dimensional matrix approach organised around three broad themes and nine sub-categories allow the decision-maker to organise and evaluate choices with an acceptable degree of rigor and thoroughness. The three broad themes are Use (divided into Core, Cyclical or Casual) – Asset Type (which can be Strategic, Specialty or Generic) and Market Environment (which ranges from Mature Domestic to Emerging Economy). Proper understanding of each of these groupings brings critical variables to the fore and allows for efficient resource allocation and enhanced risk management.
Corporate real estate managers have long understood the concept of risk. Much of their work is driven by transactions and projects related to new or changing workplace requirements. They have developed tools to ensure that these projects come in on time and within budget in an attempt to manage both the financial and operational risk at the single asset level. Nevertheless, there has been little concentration on the risk across the portfolio or the way in which that portfolio interacts with the wider property market.
When developing and implementing strategies, organisations are exposed to risk and therefore need tools to determine when, and if, these risks become unacceptable. Strategic risk is defined by Simons (1999) as an unexpected event or set of conditions that significantly reduces the ability of managers to implement their intended business strategy. The sources of strategic risk are often articulated in the strategic management literature in general terms such as technological and production risk, financial risk, product and market diversification risk, managerial ability and competence, environmental risk and competitive risk (Thompson, 2001). However, according to Simons (1999), there are three key sources of strategic risk that impact all organisations: operations risk, asset impairment risk and competitive risk. This framework provides a coherent way of grouping risks and taking each one in turn, the relationship to corporate real estate can be determined.
Operations risk results from a breakdown in a core operating, manufacturing or processing capability (Simons 1999). At the strategic level, it is related to the activities of the organisation that are critical to the creation of value. From a corporate real estate view, the potential for structural failure of a key facility could create operations risk. For instance, a leaky roof or a power failure in a data centre of a financial services organisation might lead to loss of revenue and reduced customer confidence thus inhibiting future growth and overall competitiveness.
Asset impairment risk is focused on three aspects. First the potential for impairment in the value of balance sheet assets, secondly a reduction in intangible value, and finally the physical impairment of the assets (Simons 1999). Given that corporate real estate is a key asset and a significant proportion of the net tangible assets of most corporations, this type of risk is highly relevant.
Competitive risks relate to changes in or actions by competitors, regulators, customer or suppliers. Organisations are at risk if any of these changes reduce their ability to create value and differentiate their products or services (Simons 1999).
We propose that there are two over-arching issues for management to confront. First, fully understand the nature and source of the risks borne or created in any real estate decision. Second, understand the intensity of each risk and the appropriate risk management strategy before contemplating the legal and organisational structure that will deliver the real estate assets and services.
Research in this area of real estate has expanded considerably in the past decade, but remains heavily weighted to descriptive and normative works. Empirical study of employee satisfaction, productivity, creation or destruction of shareholder value and economic efficiency of real estate costs all need to be pursued from the foundation that these earlier works have established. Research into the true impact on the firm of corporate real estate decision-making must eventually become part of the managerial strategy literature as well since it represents typically the second or third largest element of expense in most firms. The contribution of this work has been to provide a framework on which empirical work could develop by testing its validity and usefulness in practice. It could also help in the elusive search for understanding and evaluating the real contribution of corporate real estate to organizational performance.