GB540.Unit5.Assignment.FinalProject

2010 January 15 GB540: Economics for Global Decision Makers Try L. Muller

[CBRE: RESPONDING TO ECONOMIC INDICATORS, MAXIMIZING REVENUE] A quick look at some of the acute effects that economic indicators have on CBRE and its position in the commercial real-estate market with a subsequent outline of how to maximize profits given the economic factors.

CBRE: Addressing Economic Indicators

Corporate Profits Corporate profits for the commercial real estate industry are a great indicator of economic health because it is procyclical and coincidental— providing an up-to-date snapshot of the relationship between business and the economy. Profits and return on investment greatly depend on the risk taking of the corporation. Thus, when business conditions are favorable, big corporations like CB Richard Ellis (CBRE) become optimistic about future plans and how to expand operations and the workforce.

Conversely, depressed corporate profits will cause pessimism and the company will contract its operations, employment initiatives, and investments. In Q4 of 2009 65% of U.S. companies beat analysts’ expectations in regard to profit for the quarter (Aeppland and Whitehouse, 2009). However, company earnings have actually fallen almost 25% since 2008 (Aeppland and Whitehouse, 2009). Like CBRE, these corporate profits were generated by companies who significantly cut cost to render these returns (Aeppland and Whitehouse, 2009). These “empty” profits indicate that CBRE should still be reluctant to reinvest these profits into additional business endeavors because there are not substantial economic indicators to imply that there has been an improvement in the market. If CBRE was to see these independent profits as a potential trend, it runs a high risk of completely closing the margin between its operating income and operating expenses.

Inflation/Deflation The major issue is whether or not deflation will continue its current trend or will it level out before over consumption— before prices are pushed back to inflation (Christensen,

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CBRE: Addressing Economic Indicators

2009). Due to the potential for a slow economic recovery, coupled with a high rate of unemployment, CBRE could eventually start to see some operational improvement in the short to mid-term and less benefit in the long-term. CBRE will be able to increase property sales and expand its employment as purchasing power and prices balance out in the short to mid-term of this period of deflation. However, as the purchasing power increases during sustained deflation, property may eventually begin to be consumed at a higher rate than the output capacity of CBRE. Its capacity to create property and provide its other services may be pushed beyond the optimum limits and the demand for such commercial property services could begin to far exceed the company’s capabilities. Competition for property pricing could cause CBRE to offer prices under current profit margins just to hold on to its market position. The combination of demand and price undercutting could eventually decrease output and profit in the long-term.

Unemployment We have seen marginal improvements in the unemployment rate (9.5%) since unemployment peaked in Q4 of 2009 (10%) (Knakal, 2009). CBRE should not expect to see significant increases in the demand for office and industrial spaces with such a small improvement in unemployment. The company needs to realize that it will continue to lose value on its vacant properties since availability and vacancy rates will remain high as long as there is a hiring freeze. CBRE will have to focus on long-term strategies and short-term maintenance because unemployment is a lagging indicator that will not render any short-term benefits since it will improve at a slower rate than the economy— meaning not much short-term turnaround on vacancy and availability rates. Property

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CBRE: Addressing Economic Indicators

values will continue to fall until consumer spending stimulates business investments in capital— which should all be stimulated by a lowering rate of unemployment.

New Construction There has been very limited new construction activity with vacancy rates jumping from 7% to 18% over the last two years (Widhalm, 2010). If businesses are not expanding and not hiring then there is no job creation— property on the market cannot be absorbed. Commercial property— especially business parks— are built on the basis of speculative construction. The idea of CBRE putting property up for sale with the mere potential of it selling in this market is almost unfathomable. The lack of new construction is indicating to CBRE that it needs to follow suit and refrain from pursuing new endeavors because it is hard to find occupancy and financing for speculative construction right now. Also, the lack of new construction severely limits CBRE’s broker deals since any new opportunities will have to be pushed back until economic conditions allow for the market to be liquid.

Bank Credit The Federal Reserve has found that commercial banks have ceased applying new highly restrictive standards on many loan types (Associated Press, 2010). Unfortunately this does not apply to commercial real-estate loans. Even though the banks are not imposing new restrictions, the commercial real-estate market makes them very wary because it is illiquid and it is driven by speculative construction (Associated Press, 2010). CBRE will continue to have stagnant operations and have to try to recycle its income through some of its more sustainable endeavors in order to provide the 4

CBRE: Addressing Economic Indicators

company with some stability. The inability to obtain operating capital will increase the rate of income loss while operating expenses will remain the same— closing the margin even between the two even more. The market will have to be more liquid for CBRE to actually be able to use external resources to increase activity.

Interest Rates The Federal Reserve decided to hold interest rates at a mark near zero for the beginning of this year (Associated Press, 2010). This shows that it is trying to facilitate recovery and has long-term implication for CBRE. The Federal Reserve is trying to stimulate consumption through extremely low-interest loans. This should mean that CBRE may soon experience some increase in property sales and eventually see an increase in property values as consumption begins to pick up.

Maximizing Revenue The following is an outline of how CBRE can address the aforementioned economic indicators in efforts to maximize revenue: 1. Cost-cutting a. Cutting operating expenses worked for Q4 of 2009 and is a good strategy for recession-proof sustenance. i. Cut back internal costs 1. Limit

extraneous

spending

beyond

direct

compensation

including the reduction of executive perks 2. Institute a hiring freeze and contract temporary work where needed ii. Cut back external costs

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CBRE: Addressing Economic Indicators

1. Freeze all speculative endeavors and only engage in projects with non-speculative parameters; preferably with partners 2. Attempt to share risk in all endeavors 3. This provides a stronger foundation by which to obtain commercial loans from banks and help short-term cash flow problems 4. Focus short and mid-term strategies on property management services and broker deals 2. Short to mid-term strategy: Early hedge on deflation a. Start to address strategies for filling vacant properties i. Make selling prices and rents more negotiable ii. Devote resources to research and sales; be more proactive about finding potential occupants iii. Continue to find partners with whom to combine capital resources to pursue opportunities in the early stages of deflation before competition picks back up 3. Lay out a long-term plan to move with the rate of deflation i. Conduct a risk assessment 1. Global vs. domestic opportunities and their implications 2. Is there a need to eliminate operations in an unfavorable global economy? ii. Liquidity analysis 1. How liquid is the company on a global and domestic landscape?

2. Where are you seeing a higher return on assets iii. SWOT analysis given the current economic situation 1. Perform this on a global level 2. There may be less threats and more opportunities globally a. i.e. capitalize on China’s high property values and low unemployment rate

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CBRE: Addressing Economic Indicators

Associated Press. (2010).“Fed sees signs that credit crisis easing”. Retrieved from MSNBC.com database: http://www.msnbc.msn.com/id/35186153/#storyContinued Aeppel, T., Whitehouse, M. (2009). “Cost Cuts Lift Profits but Hinder Economy”.

Retrieve from The Wall Street Journal: http://online.wsj.com/article/SB125539122868481389.html Chistensen, J. (2009). “Inflation Expectations and the Risk of Deflation”. Retrieved from Federal Reserve Bank of San Francisco database: http://www.frbsf.org/publications/economics/letter/2009/el2009-34.html Knakal, R. (2009) “How Unemployment and Deflation Could Affect Commercial Real Estate Values”. Retrieved from the Real Estate Channel database: http://www.realestatechannel.com/us-markets/commercial-real-estate-1/robertknakal-massey-knakal-real-estate-commercial-real-estate-values-new-yorkcommercial-real-estate-sales-2009-cap-rates-roi-calling-a-bottom-1022.php Widhalm, S. (2010). “Commercial Construction Projects Slow with Economy”. Retrieved from Reporter-Herald database: http://www.reporterherald.com/news_story.asp?ID=26364

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CBRE: Addressing Economic Indicators

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