Return on Investment is an important concept in finance. It is a key tool for someone investing money to figure out whether that investment is a good decision. A positive ROI means that there is more money coming in for the investment than going out. When comparing two possible investment opportunities that are otherwise equal, ROI is often considered a good way to decide which one to choose.
Corporate Real Estate is often looked at as either a cost or an investment. Constructing a workplace environment can take a significant amount of cash to purchase furniture, carpet, paint, new IT equipment, and all the other things that go into an office. Often, this money is spent on either refurbishing or relocating an existing environment that had an existing cost. Only in rare circumstances does the new workplace deliver an annual cost lower than the original cost. Between inflation and depreciation that previously burnt off, new real estate is an expensive proposition.
Where corporate real estate delivers a strong return on investment is 5 to 10 years after the initial construction that does not need significant refurbishment. If you build the workplace right to start with, it should last a long time and not require a high level of re-investment. If space is built out cheaply or inadequately, it will need constant refurbishment and improvement hurting long-term cashflow.
It is not good practice to view a corporate real estate project through an ROI lens. If the project generates a strong ROI one of a handful of things happened:
- Original space was over-built at a high cost and the new space is bringing costs back in line.
- The previous lease was signed at the top of a market and a renewal is allowing the cost to be brought down.
- New workplace concept is being implemented that is allowing a significant reduction in space (usually 30+%) that overcomes increased market and construction costs.
Almost every other situation results in an increased annual real estate cost with a negative ROI. Reviewing real estate costs this way will result in minimized investment which will end up increasing future costs to the business. Corporate real estate is about opportunity costs. Yes, reduced real estate investment today means you have more dollars to put toward other activities. But it may also mean that you have fewer dollars next year or the year after to put to other projects.
If real estate receives no cash for its projects, a few events kick-off that will have long-term impact:
- Leases will be renewed on shortened terms in anticipation of possible future investment. Short term renewals often come at significantly higher annual costs because the landlord is accepting a higher likelihood of exit at the end.
- Projects are completed on the cheap with less technology, more reuse of furniture, and fewer amenities. This results in a lesser experience for colleagues in that office and a higher rate of future investment. This prevents future depreciation burn-off from ever completing.
- No ability to deliver projects which deliver needed business change (e.g. consolidating sites, upgrading old sites, relocating to more desirable locations, improving technology infrastructure).
Over time, these events lead to annual corporate real estate costs increasing at a rate faster than inflation. This increase then means that there is both higher future demand for cash and a higher operating cost to maintain the environment. Together, these two factors lead to a risk of that future investment being higher than the business desires.
At the end of the day, corporate real estate helps the business operate. If you choose to not spend money on it, it’s the same as not spending money on business operations. Hiring an HR manager is not looked at from an ROI perspective, spending money on appropriate real estate environments should be the same. When a real estate project does have an ROI, often it means that someone did something wrong previously or a major change is being made.