REAL ESTATE COSTS: Creating flexibility in a fixed cost.

Real estate costs are the classic example of a fixed cost: they do not change over the short term and for the most part do not vary with changes in revenue. Amortization, depreciation, property taxes, rent, and even most utilities are fixed in the short term.

Over a long enough time frame real estate holdings can be modified in response to changing needs and cost imperatives. A lease can always be allowed to expire, in some instances a suitable subtenant may be found, and, for a price, excess space can be repurposed.

In the short term, however, this flexibility is much more difficult to achieve. Given the high cost of medical office build­outs, many healthcare organizations lack the ability or the desire to enter into the shorter-term leases which support this vision of flexibility.

There are a number of strategies an organization can employ to enhance or maintain flexibility in its real estate portfolio.

  1. Ladder your leases. A bond ladder is a portfolio of fixed- income securities in which each bond has a significantly different maturity date. A lease ladder is a portfolio of leases with different maturity dates.

If organizations grew at a fairly constant rate over time, a lease ladder would naturally evolve. Most institutions, however, have growth spurts, resulting in significant portions of their real estate portfolios being negotiated under similar market conditions. In addition, organizations often focus on making leases coterminous, with the future goal of co­locating certain activities. The cost of this concentration of lease expirations is a reduction in the flexibility an organization has to downsize or re­locate an activity. In addition, if a large portion of a lease portfolio is renewing at the same time, the organization is increasing its exposure to upward swings in market rental rates. A lease ladder allows for the equivalent of dollar-cost averaging in a stock portfolio. By negotiating leases throughout the market cycle, there is the potential for a lower average portfolio rental rate.

  1. Standardize tenant improvements (TI). The fact that every Starbucks or McDonalds looks pretty much the same is not just a marketing strategy, it is also a way to manage costs.

Standardization of fixtures, finishes, furniture, equipment (FF&E), and, when possible, layouts, can significantly reduce tenant improvement costs. This reduction comes about through lower architecture and engineering fees, and the potential for reduced pricing of FF&E. Standardization also increases the ability to shuffle space users. Even when total standardization is not possible because of varying program and licensing requirements, the sharing whenever possible of TI standards and FF&E will help limit the initial investment in a space. The downside? A perceived loss of control or status symbols by the space users.

  1. Intensify usage. Many healthcare organizations are already timesharing physician office space. This same strategy can also be used for other patient care activities.

Not only can different physicians use the same office suite to see patients on different days and times, but different departments can as well. Wellness and screening programs can run after work sessions in space used by other patient-focused activities during the day. Adding a second shift in the early evening hours can increase the efficiency of medical office space. Departments forced into these space sharing arrangements may argue that employees become less efficient without dedicated offices. However, other industries have already trail blazed this practice, and the continuing move towards electronic medical records will facilitate this option.

Flexibility in an organization’s mindset and approach to real estate will create new opportunities to manage this classic fixed cost.

Other Matters

 I’m writing this as the end of summer is rapidly approaching along with the end of many organizations’ fiscal year.  With so much uncertainty in both the healthcare markets and the world in general, projecting and planning for the future is tough.  Flexibility and adaptability are more important than ever.

The current book I am reading,  A GENTLEMAN IN MOSCOW by Amor Towles, is a light summer read which underscores this point.  A Russian aristocrat stripped of his title and belongings during the Bolshevik Revolution is placed under house arrest in a Moscow hotel. His ability not just to adapt, but to grow and some might say thrive in these diminished circumstances, is testament to the importance of FLEXIBILITY.