COMING TO TERMS
CFOs are turning to property management outsourcers to cut better deals on leases.
By Steven Crane

In the past, says Colin Wadsworth the Hong Kong-based vice-president of finance at Sony Music, "our negotiations with landlords were mainly to ensure that the lease terms weren't too outrageous. Unfortunately, they always were." Until recently, Wadsworth says, Sony's landlords held all the cards. "During our last negotiations in Hong Kong in 1994," recounts Wadsworth, "if I had pointed out that the price per square foot included such unusable space as columns and lift lobbies, the landlord would have laughed in my face." Wadsworth shakes his head. "Negotiations were unbelievably one-sided."

Of late, however, finance managers like Wadsworth are finding that the odds are evening up a bit. With a 55 percent drop in commercial rents in Hong Kong since November 1997, corporate tenants are no longer having to beg for space at any cost. While some CFOs have chosen to exploit the drop in rents by dealing directly with landlords, real estate consultants say face-to-face negotiations can be hampered by a tenant's desire not to upset a long-term relationship with a landlord. Managing director at real estate services provider Cushman & Wakefield (C&W), Michael Creamer, says: "The problem with that approach is that 99.8 percent, if not 100 percent of landlords, will gouge their tenants."

This nasty fact of life is leading a number of CFOs to seek outside help when wrangling with landlords. Indeed, industry watchers say property management outsourcing is becoming big business in Asia, as many consulting firms seek partnerships to extend their global reach. The world's largest property consultancy, Jones Lang Wootton, recently merged with US-based LaSalle Partners to create a publicly listed company with a market capitalization of US$900 million. And Hong Kong-based First Pacific Davies has boosted its international position in a partnership with UK-based Savills. As business becomes global, says one property advisor, so must their service providers.

Outsourcers offer substantial benefits. For openers, property management outsourcers, usually commercial real estate veterans, tend to know the ins-and-outs of the property game. That knowledge helps them wring substantial concessions from landlords. "Because property consultants are wired into the market, they're able to push the landlords for better terms. Terms that I would be embarrassed to demand," says Wadsworth. With the assistance of a property advisory team, Sony recently concluded a deal for its new regional headquarters in Hong Kong. Wadsworth reckons the outsourcer shaved 10 percent more off the rent than he could have managed on his own. That's a sizeable savings - particularly since rent is often a company's second highest recurring expense, after salaries.

Even better, real estate advisors typically charge their fees to landlords, not to tenants, providing the landlord-tenant relationship is exclusive. That means companies have little to lose when engaging a property management outsourcer. And as Wadsworth points out, property advisors relieve finance directors of the often unpleasant task of dealing with unaccommodating property owners. Says Wadsworth: "Its better to have someone else yell at the landlord."

Professionally speaking, real estate advisors don't seem adverse to raising their voices. In Hong Kong, explains Creamer, the spread between initial offers from landlords and C&W-negotiated final contracts is 30 to 50 percent. Creamer cites one client - a US multinational that just signed a three-year contract on a 14,000 square-foot office space - where the agreed-upon rental price amounted to HK$10 million less (US$1.3 million) than the landlord's initial offer.

The problem with the attitude of many corporate tenants, says Creamer, is they firmly believe their landlord won't screw them. "Unless challenged," he says, "a landlord will just smile and say what a great tenant you are - and then tell you how much they want. Only by challenging costs can tenants command some respect."

Bending the Rules

It would be a gross generalization to say that all landlords have the scruples of a Bowery bum. But property management outsourcers can help clients avoid some of the more dubious practices routinely employed by landlords. The most obvious (and widespread) example of chicanery, perhaps, is the method landlords use to calculate space. In Asia, says Richard Middleton, director of research and advisory services at Cushman & Wakefield, there is no standard base measurement. Landlords can inflate the true square footage of an office - and thus the rent - by using a definition that may include anything from window ledges to the swing door space into the toilet.

The best way to get around this, argues Middleton, is to calculate rent based on the space an individual occupier operates from - that is, the net usable area. Generally speaking, net usable area is space where a tenant could reasonably be expected to put down carpeting. Middleton advises clients not to take quoted efficiencies at face value. "In this market," Creamer points out, "space has a habit of growing in the landlord's favor. What was 8,000 square feet a year ago is now 9,000 or 9,500. When rates are dropping the landlord employs an expandable ruler."

Not all the blame for miscalculations, though, rests with landlords and their rulers. In truth, 10,000 square feet in one building may lay out better - and therefore accommodate more staff and equipment - than 12,000 square feet in another. What's important, says Creamer, is to examine total occupational costs by dividing rent into square footage. In negotiations for corporate clients, Creamer says his tactic is to drive down the square footage, and therefore the rental charge. "It's easy to say 'why bother' about a one dollar reduction. But if you've got 50,000 square feet, at a dollar a foot over six years ... well, do the math."

Of course, rent isn't the only thing a corporate tenant must consider when negotiating with a landlord or management agency. Creamer notes that management charges and service fees and taxes vary wildly across the region. In Hong Kong, while rent free concessions of up to 24 months are possible, service charges for air conditioning are not included. In Singapore, rent free periods may be shorter, but service charges are included and property taxes are nil. The point: CFOs need to factor in all occupancy costs to arrive at a true bottom-line figure.

That can be difficult, particularly if a company operates in several markets. Compounding the problem: regulations in some countries in Asia actually prohibit tenants from checking on fees or a management company's books. Not surprisingly, such regulations mean corporate tenants often end up forking over more money to landlords than what they had budgeted. "There may be an annual fixed rise in electricity costs, for example," Creamer says, "even though electricity costs have been stable for two years."

Conversely, CFOs need to factor in concessions from landlords when assessing the true costs of renting. In Sony's case, a generous rent-free period was sweetened with an escalation clause that pegged the rent at an advantageous rate for the first three-and-a-half years. Thereafter, Sony's rent is capped during the first option period at the lower end of market prices, or "X" number of dollars - whichever is lower. Although Sony may pay out a bit more in the short run, Wadsworth has effectively hedged against any drastic run-up in long-term real estate prices. "Even though the rent at the time the option comes into effect may be more than the current rate," he points out, "it will still be lower than it was three years ago. I'm comfortable with that."

A Moveable Feast

Not all CFOs, however, are sold on the merits of property management outsourcers. Michael Courtenay, vice president and CFO at advertising agency McCann Erikson Asia Pacific, recently coordinated his company's efforts to win rent reductions, particularly in more depressed local markets in Thailand, Singaporeand Hong Kong. Courtenay says he's achieved results without the benefit of outside help. In Bangkok, for instance, Courtenay extracted back-to-back reductions - two years ago he negotiated a 10 percent drop in rent, and recently knocked another 47 percent off his company's commercial rent. "We put it to the landlord that we had already lined up alternative properties at X number of baht," says Courtenay. "With no further prompting, the landlord replied he could do better."

Not long ago, a sellers' property market meant that Courtenay had little choice but to accept the dictates of landlords with equanimity. Options were limited then, he explains, and the ad agency tended to stay where it was and just live with the terms of its lease. Now, though, Courtenay, along with McCann Erikson's finance directors, who oversee operations in 20 countries in the region, find direct negotiations generate real savings. In some cases, landlords will reduce costs before a lease expires knowing that, in today's market, a tenant can quite easily move from a class B building to a class A office - and pay less rent. Courtenay points out that although real estate is not the company's core competency, the evaluations and analysis necessary to conduct property negotiations are well within the capabilities of the finance function. "It's not something we need to go outside for," says Courtenay. "They're not terribly difficult to do."

Indeed, Courtenay believes retaining control over property expenses and relationships with landlords is good corporate policy. At bottom, he insists, the whole process of calculating the net effective rate for occupancy costs - usable space, concessions, management fees, taxes, and the like - is within the reach of finance managers.

Nevertheless, Courtenay appears willing to consider outside assistance - if it can add value. Over the last year, Courtenay has engaged a real estate advisor to evaluate the company's current leases, refine strategies and identify new properties. To date, no formal outsourcing arrangement has been signed, and Courtenay has insisted his company handle first round negotiations directly. "We'll strike our own best deal, and if the advisor can do better then we'll work out a fee arrangement where the savings are split."

Still, the McCann Erikson CFO does see some advantages in bringing in property advisors. "Most CFOs just don't have enough time to do their own jobs - never mind going out to search for the best price on real estate." And while Sony's Wadsworth does not advocate handing over all a company's real estate functions to an outsourcer, he thinks property advisors offer expert advice. And expert - and trustworthy - advice is often in short supply in the real estate business. "If I need medical advice I go to a doctor," Wadsworth explains. "If I need property advice, I go to a real estate advisor."

Steven Crane is CFO Asia's Hong Kong bureau chief.