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Commercial real estate:Why a rising tide won’t lift all boats 
Though many observers believe thatthe recession officially ended in thesummer of 2009, most industries,including commercial real estate(CRE), continue to feel its effects. CREindustry fundamentals remain weak, andaccording to many industry estimates, nomeaningful recovery can be expected until2011 at the earliest. This is not surprising,given that the CRE industry usually lagsbehind the general economy by 12 to 18months. The extent and timing of CRErecovery will depend upon geographicmarket and asset class (e.g., office,industrial, retail or multifamily).Will the recovery in the broadereconomy and in local property marketsprove to be the panacea for the industry?If history is any indication, companieswould be ill-advised to rely solely onthis wave of the recovery to remaincompetitive or even viable.beginning of the period, with the firstquartile comprising the best performersand the fourth quartile comprising theworst. The yearly median ROA foreach quartile was tracked to determineperformance trends. In addition, theMoody’s/REAL Commercial PropertyPrice Index (CPPI) was applied from2000 forward to determine pricing trends.Grant Thornton LLP compared thereturn on assets (ROA) of 100 real estatecompanies, mainly real estate investmenttrusts (REITs) with publicly availabledata, in order to evaluate portfolioperformance from 1997 through 2009.This period includes the 2001 recession.The companies were divided into fourquartiles based on their ROA at the
Quartile 1 Quartile 2 Quartile 3 Quartile 4 Moody's/REAL Commercial Property Price Index (right axis)
How recession changes the competitive landscape
Median ROA trends by quartile
1.02.03.04.05.06.07.00.01997200919992008200320012005 1.01.21.41.61.82.0ROA %Source: Grant Thornton LLP199820002002200420062007RecessionPost-recessionaryshiftsThe asset pricebubble
CRE industry fundamentalsremain weak ... no meaningfulrecovery can be expecteduntil 2011 at the earliest.
 
This analysis produced several notablefindings:• The median ROA for each quartiletrended downward, with the 2001recession placing disproportionatepressure on companies in the first andfourth quartiles .• The median ROA of the top threequartiles converged over time. Inlayman’s terms, this means thatthe best performers pre-recessionenjoyed little or no benefit to ROAperformance post-recession comparedwith the relatively weaker performers.• Both the 2005–2007 asset price bubbleand its subsequent burst are readilyapparent. As industry ROA stabilizesand begins to rebound, asset prices willmost likely improve, thus reflecting amore normalized relationship betweenreturns and prices.Our findings suggest that benefits froma recovery are redistributed among industryplayers and are not necessarily correlated topre-recession performance levels.To understand why this might bethe case, let us consider the hypotheticalexample of two CRE companies,Company A and Company B, that aredeemed comparable in performance priorto the recession. The recovery in both thebroader economy and the local propertymarket will provide a similar boost toboth companies. The key performancedifferentiator is the value added or erodedbecause of actions taken — or not taken— during the recession. In this example,the net value added by Company Aduring the downturn fell short of thatadded by Company B, resulting in apost-recession performance gap betweenthe companies.The reasons for such a performancegap are twofold. First, most companieshave a tendency to operate in survivalmode during a downturn, concentratingonly on short-term results. This thinkingoften leads to actions that deliver little orno value in the long term; in fact, many
Commercial real estate: Why a rising tide won’t lift all boats
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 What causes the performance gap?
ROA performance of pre-recession peers
Company A Company BPerformance gapValue addedMarketEconomyPre-recessionSource: Grant Thornton LLP
Our findings suggest that benefits from a recoveryare redistributed among industry players and are notnecessarily correlated to pre-recession performance levels.
of these actions have the potential toerode value. Second, some companies areoverwhelmed and attempt to implementtoo many changes at once. As a result,very few changes are executed effectively,while important strategic initiatives maybe ignored entirely.
 
•
Conformer (low value, high costs)
—Actions in the upper left quadrant arecostly to implement and have minimallong-term impact. These actions oftenrelate to problems which shouldhave been addressed previously,such as weak or dysfunctionalinformation and control systems, alack of discipline in executing agreed-upon plans, and a cash managementsystem inconsistent with stakeholderrequirements. Correcting theseproblems in a shortened time periodcan be costly in terms of both timeand dollars. Companies carryingout actions that fall in this quadrantshould attempt to move toward moremeaningful, higher-value initiativesthat yield more results for thesame cost. Alternatively, if limitedresources are available after a companycompletes mandatory activities, itcan initiate low-cost, high-impactprograms such as those included in the“cherry picker” quadrant.We recommend that CRE companiesmap the universe of available actionson a cost-value matrix that has twodimensions: the long-term value addedand the short-term costs incurred.Actions taken by the company will fallinto one of four quadrants:•
Myopic (low value, low costs)
—Actions in the lower left quadrant arenot costly to implement, but they havelow (and in extreme cases, negative)long-term impact. One example of this kind of activity is leasing to riskytenants in order to boost short-termoccupancy. Similarly, companiesoften slash capital spending andselling, general and administrativecosts without analyzing the long-termimpact of doing so. A company shouldavoid taking actions that decreaselong-term value and should minimizelow-impact actions that may distractmanagement from pursuing strategicinitiatives.•
Cherry picker (high value, lowcosts)
— Actions in the lower rightquadrant are not costly to implement,yet they have high long-term benefit.Examples include a review of portfolioperformance, disposition of noncoreassets, cash generation measures,and a reduction in overhead anddiscretionary capital expenditures.Because these actions are the corporateequivalent of low-hanging fruit,a company must assume that itscompetitors are taking advantage of them. Any company that strives tobe more competitive must considerinvesting additional resources ininitiatives with the potential totransform it into a market leader.•
Forward thinker (high value, highcosts)
— Actions in the upper rightquadrant are costly to implementbut have high impact. Most of theseactions demand the use of resources— capital, time, labor — withoutoffering short-term returns. Examplesinclude strategic capital investmentssuch as the reconfiguration of leasedspace, new or redesigned marketingprograms, and strategic acquisitionsand divestitures. Unsurprisingly,not all companies are willing — oreven able — to make such costlyinvestments, particularly duringa recessionary period. But it’simportant to remember that eventhough these actions do not yieldimmediate results, they do have thepotential to set the business apartfrom its competitors.
Commercial real estate: Why a rising tide won’t lift all boats
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Reaction to the downturn
The four quadrants of company action
LowHigh
Long-term valueShort-term costs
LowHigh
MyopicCherry pickerConformerForward thinker
Source: Grant Thornton LLP
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