08 May Real Estate: The Albatross of Today’s Virtual Business Model
In working with a recent client in the IT services market, he made a very poignant remark regarding the real estate owned by the business:
...this thing is like an albatross around our necks
Today’s virtual businesses represent an extremely different model from the companies of just a couple of decades ago. Most of today’s cash-cow companies require more brainpower and human capital than actual physical property. Moreover, many of today’s successful businesses were started with nothing more than a laptop in a coffee shop or a time-leased space in some type of virtual office. This particular client had a couple of things going against him when it came to his real estate.
- After the end of a good year with his business in 2008, he purchased his commercial building at the height of the market. Subsequently, his company’s cash flows significantly decreased with the market and so did the value of the property–a double-whammy which still has yet to completely recover.
- He operates a virtual staffing company with most of his w2 and contract employees residing at the client site most of the time. His 10K square foot office space sits empty about 99% of the time, except during a weekly meeting. That weekly meeting is a big cost at $15K per month–which is what his current mortgage payment totals on the place.
- We were representing him in a sell-side engagement. None of the right business buyers wanted to touch the property and because the cash costs were on the P&L, we couldn’t, in good conscience, make the adjustments to the bottom-line in the assumption the business would be moved–so it had a natural drain on cash flows.
He informed me that he could get the very same utility out of a $5K monthly lease on a smaller, but large enough piece of real estate and operate much more cash efficiently.
Not to knock commercial real estate. It certainly has its advantages, the main one being a tax shelter and an hopeful equity growth vehicle over time. It also provides leverage and, in some cases, a good cash yield, especially if you can co-locate with other companies. The problem with our little example here is that it was too much for what they needed. The amount of interest they were paying, even after the tax advantages and low interest rates–and even the equity being built by their monthly payments–couldn’t compare to the returns they could have received elsewhere.
Think of it. An extra $10K a month in cash flow is enough to hire a very good Enterprise salesperson to assist in the company’s growth. If not that, then investing in other forms of advertising and marketing could also be a big boon long term. It could mean landing a couple more big accounts year-over-year to help establish the business as a growing force.
If nothing more, a no-load indexed mutual fund with $10K going in might have better returns than the equity he’s building in his commercial property, especially since said equity still has yet to fully recover since 2008. Oh, and did I mention they had to put over $200K into the building in remodeling?
Not every situation will mirror this, but our treatment of commercial real estate in business can and should be treated like how we operate in cloud and virtual environments in computing: only pay for what you use and use the cash you save to plow back into the business. Sure, it’s only an efficiency innovation, but it beats the ole’ ball-and-chain of a commercial property.