To sell or not to sell a property? RODNEY TIMM looks at the underutilised owned assets of businesses and ways to avoid foreclosing on their value.
Many businesses, particularly in the industrial sector as well as other enterprises such as church groups, sporting groups and community clubs, have owned property assets that are underutilised and rapidly becoming functionally obsolete and in a poor state of physical repair. Often these organisations do not realise the underlying value of the site based on alternative and improved uses. This happens as urban populations grow, and urban residential sprawl starts moving into peripheral zones that were typically focused on employment uses, semi- agricultural and light manufacturing activities. But these underutilised assets may also be near or central to residential and business areas, particularly in the church, sporting and social clubs, when there has been a drop-off in membership, and fees and
use charges do not cover the most basic maintenance. The tendency starts a downward spiral of relevance as the condition of physical assets and sporting facilities gets worse, membership numbers decrease and fewer fees are collected, leading to even less maintenance.
THE WORLD HAS CHANGED
It is evident that over the last decade most of the world as we know it has changed. The need for and use of physical assets has transformed significantly as evolving connectivity and converging technologies continue to change everything we do in a business, leisure and a social context. As a result, the nature of the physical structures and the properties that we previously needed to manage our business or conduct commerce enterprises, and even enjoy social and leisure activities, are often no longer required in the same format and size as was previously the case. The production or distribution complex no longer supports the company needs with just-in-time delivery from a cheaper labour economy – the business premises may now be irrelevant with customer contacts done virtually. Even social clubs and sporting fields are no longer patronised to the previous extent or in a similar way.
Often there is an emotional attachment to these owned properties, however, particularly if this is the place where that business started out, or the chairman of the sporting club won the championship when he was an emerging talent. In addition to this attachment, there
is the tendency in small- to medium-sized companies and older family-controlled businesses – as well as in clubs that have autocratic or ineffective management committees and membership structures – that inertia and the inability to make decisions becomes the norm. As a result, despite the deterioration in the condition of assets or overcapitalising on properties by continually having to spend the limited available capital inappropriately, in attempts to extend the life cycle, the hard decisions are not made.
Often the lack of good objective decision- making related to properties and assets, with the inability to put aside emotional attachments, can lead to the demise of the business or the club. For example, it is obviously preferable to sell off an inefficient production facility with an increasing higher- and-better-use land value, despite it being where the business commenced, than to fund and relocate to a new state-of-the-art processing plant – even if it’s many kilometres away in a new emerging industrial hub, with ease of access to the freeway system. This strategy may prove to be the salvation for an ailing company, providing a renewed ability to compete with efficient productivity, ease of distribution away from congested streets and ultimately excel in the face of new emerging competitors.
For example, for a golf club, it is likely to be a better strategy to embark on reducing the length of a number of holes, even reducing par by a few strokes, to improve the player amenities and reverse the declining membership trend. This may require having a new residential or senior-living complex, developed on the excess or freed-up land, to fund the changes – but a better option than having the bank move in and appoint administrators. With better player facilities and golf course condition, more members are likely to be attracted, and with fee revenue growth ongoing, maintenance and services can be improved, providing longer-term sustainability.
But often, without too much foresight, the sell-off of owned property assets is a last ditch effort by the business or club leadership to bolster revenues and cash flow. And under pressure, the ‘family silver’ in the form of the property is handed to an eager all- promising developer or property speculator for a pittance, without the leadership fully understanding the underlying value. Although the cash injection could be the boost required to keep the enterprise going, many millions of dollars worth of value may have been ‘left on the table’ in an over-hasty negotiation and disposal. These types of transactions usually occur immediately prior to financial year-end, providing a boost to the past year’s performance – but what happens the following year when these pressures arise again? With a few basic rules within a governance structures these over-hasty sell- off decisions can be avoided.
PROPERTY SELL-OFF TRAPS
Selling a property that is no longer operationally suitable, functionally obsolete or declared as excess to requirements, is fraught with challenges for the uninitiated. Selling a commercial property is more complex than selling a residential home, and the kinds of poor sales decisions and traps, many of which overlap, that seem to occur regularly can be categorised into a number of groups, including the following:
- Disposing of a property without fully understanding the upside potential and the ongoing liabilities that may be attached. Selling quickly can be attractive, particularly if the financial year-end is imminent, and business profits need to be bolstered. And realising a healthy profit over the book value can provide a distorted perspective and result in potentially leaving millions on the table. But the true upside value and potential ongoing liability risks, such as remediation, are determined by many variables that are seldom encapsulated in a single valuation report.
- Getting lured into a disposal transaction that seems ‘too good to be true’ by an unsolicited approach from a developer or builder is usually fraught with unexpected and unwelcome surprises. For the uninitiated, property disposal
and development processes are complex with many hidden risks and costs. Poorly drafted documentation, usually prepared by the purchaser’s solicitor, can mean that the proceeds of the sale at the end are likely to be significantly less than what was originally offered. Often the transaction is structured with a relatively low upfront purchase price, with the promised upside revenue coming from the development profit that is to be split between the parties over the medium term as revenues are received. However, this revenue is calculated after deducting the development infrastructure, management, marketing and other related costs, which always seem to be far greater than originally estimated. But at this stage, the vendor is locked into the sales process even if the ultimate price after being adjusted for costs and risks is significantly below the initial promised price.
- Being convinced by a purchaser to invest operating capital from the business into the development process, or to have financing mortgage lodged on the property before receiving the full sales consideration. This can ultimately lead to disastrous outcomes. It is usually framed as being necessary ‘to fund the development infrastructure and working capital requirements’ in return for an increased share of the upside net revenues. Often this form of vendor financing, because of development delays and challenges that arise, can ultimately starve the business-as-usual operations of cash flow and destroy the business. Or, if the development process is excessively delayed and the financiers move in, the business faces an administrator selling the property and needing to relocate.
- Another approach that can lead to a poor ending is when a business determines that the development process is relatively easy, the risks manageable and the profit potential is huge. Without the required skills, experience and understanding of the development process internally, by default the company quickly morphs into being a developer, taking risks that are not fully understood or priced. And with the funding being provided by the business’ free cashflow, the business quickly moves from being a stable known operating model to becoming a high-risk speculative developer. With even slight changes in the property market dynamics or with planning approval delays, the development process can quickly absorb the company’s capital backing.
- In all sale and development processes, ot having the appropriate professional support and financial modelling controls aligned to the sales or the development agreement means that there is little control over the process and the proceeds of the development. With experienced support to model all costs and risks of the process, and to allocate these appropriately, is essential to determine the net revenue sharing and to ensure that the seller of the property receives the revenue as agreed.
Probably one of the biggest mistakes companies make is being stuck in decision-making inertia. These companies continue to operate from obsolete premises that are not aligned to new business processes, because ‘this is the way we have always done it’. The whole process of new site selection, new build and relocation are deemed to be too much effort and ‘business as usual’, with poor processes, continues. As the company slowly loses market share, margins come under pressure and eventually the business is forced to close. ●
Rodney Timm is a director of Property Beyond Pty Ltd.
This article also appears in the August/September issue of Facility Management magazine.
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