Corporate Real Estate - Newspaper Headlines

1. Corporate Real Estate - Newspaper Headlines • September 15, 1988: LA Times • LA real estate developer offers NWA (Northwest Airlines) $200 million cash for 50,000 sq. ft. building in Tokyo used to house airline employees. NWA has owned to property for more than 30 years. • January 24, 1989: Wall Street Journal • Investment bankers are searching for firms owning Japanese real estate. NWA is listed among other firms as having significant real estate (worth as much as $400 million). • March 29, 1989: LA Times • NWA received buyout offer, stock price rises 15.8% (to $71.375)

2. Corporate Real Estate - Newspaper Headlines • March 31, 1989: LA Times • Marvin Davis offers $2.6 billion for NWA ($90 / share). Notes Japanese real estate worth approximately $300 million which could be sold to finance buyout. (Stock price closes at $84.875) • June 25, 1989: The Washington Post • NWA accepts $3.64 billion acquisition offer. Article reports that NWA owns 5 pieces of property in Tokyo including a residential compound purchased in the 1950s and a 212-room hotel located 15 minutes from Narita (1 hour from city). Real estate reportedly worth over half a billion dollars.

3. Overhead Set #10 Thinking About Corporate Real Estate Decision Making I. Real Estate as a specialized input to production, not an investment in another line of business A. Factors affecting the decision to own or lease for a long term 1. Asset-liability duration match quality a. Life cycle of firm’s product--probably has been decreasing in length over time 2. Liquidity of committed capital a. Cost and ease of selling/subletting 3. Yield on committed capital relative to firm’s true cost of capital a. examine yield to landlord if space were leased; compare to internal hurdle rates 4. Management Costs a. including distracting management from from core businesses

4. Corporate Real Estate II. Firms Should Obtain Operating Facilities at Lowest Long-Term Cost A. Facility needs dictated by usual factors 1. Usage intensity 2. Growth prospects 3. Corporate image 4. Product availability (of space)

5. Corporate Real Estate • Decisions To Consider: • Should your firm lease/own property short or long term? • Should your firm rent or buy?

6. Corporate Real Estate B. The sometimes false allure of the cost savings of long-term leases or ownership 1. If competitive environment is changing rapidly, valuable capital is tied up; major cost of any long-term commitment is lost return arbitrage opportunities 2. The flexibility of short-term leases often is incorrectly valued in financial analyses a. There always is a flexibility premium in that discounts are greater on LT leases b. i.e., the rent per square foot is less on a 15 year lease than a five year lease; hence, simple comparison of the rental costs of three 5-year leases versus one 15-year lease will always show the long-term lease is less costly c. correct analysis recognizes probabilities of leaving space over time and costs of subletting (see attached spreadsheet example) d. should think of problem as M&A exercise in which consolidating merger occurs with some positive probability in any given year

7. Corporate Real Estate III. Understanding the Benefits of Shorter Leases and Buyout/Penalty Clauses A. Goal should be to obtain benefit of lower long-term rental rate at price of sharing upside value in the event you want to get out of lease 1. e.g., structure lease with long-term rental rate, but with renewal options and stiff cancellation fees 2. cancellation typically will arise when you have opportunity to redeploy capital profitably; must be willing to share some of the upside from that redeployment with your landlord-- that is the price of flexibility and it should be easiest to pay at this time

8. Corporate Real Estate IV. Making Ownership Commitments A. Factors leading to ownership 1. Realistic return expectations exceed your cost of capital (remember that real estate is a specialized production input for most firms, not a distinct line of business) 2. Underdeveloped local market a. ownership may be the only viable option in Baku 3. Idiosyncratic facilities are required a. e.g., specialized production sites in the computer chip businesses; companies such as Intel need absolute control of the site to maintain cleanliness for chip production

9. Corporate Real Estate V. Strategically Liquefying Current Owned Properties A. Obtaining matching debt financing--off-balance sheet and nonrecourse if possible (usually, it is not feasible) B. Sell properties outright 1. Includes option of swapping properties for shares of REITs or partnership units of UPREITs

10. C. Tax-free spinoffs to shareholders 1. Legally cumbersome, but option should be examined in each case 2. Requirements a. Firm must be in the business they are spinning off 1. i.e., need to have sublet space before or provided advisory services; should set up operations to permit this b. Maximizing shareholder value is not a valid reason under the tax law, so you need a strategic business reason c. Must pass through at least 80% of any gain to shareholders; thus, firm cannot retain a substantial portion of the value of the spinoff

11. Corporate Real Estate VI. What if the non-real estate firm wants to invest in real estate for strategic reasons (i.e., the investment is in a separate line of business and is not being made to purchase a specialized input into the production process)? A. Examine other ways to invest 1. Traded equity 2. Traded debt 3. Opportunity funds as a principal B. Firm’s capital will be appropriately priced in this case (although appropriate discount rate for NPV calculation purposes will be a real estate industry rate in this case in which shareholders have provided money to the firm to invest in real properties)