Corporate Real Estate Journal Volume 6 Number 1
Don’t leave money on the table when selling corporate real estate assets — Real estate transactions do not need to be a liability any more: A case study on selling CRE assets in a transparent manner Allan Kehlet Rieck and Kees van der Linden Received (in revised form): 14th July, 2016 TrueMarketValue ApS, Gammeltorv 6, 1457 Copenhagen K, Denmark Tel: +45 21 79 01 59 E-mail: Allan@truemarketvalue.dk
Allan Kehlet Rieck led Corporate Real Estate Management in the Maersk Group from 2008 to early 2016, when he joined True-Market-Value .com as Managing Partner. TrueMarketValue is an independent transaction advisory focusing on helping property sellers to sell better. Kees van der Linden was Vice President of Real Estate in Philips International since 2000. He occupied various international Corporate Real Estate functions in Philips and was also responsible for all real estate transactions worldwide, where he divested 50-plus properties in various parts of the world, including the €425 million High Tech Campus transaction in Eindhoven, Netherlands. He has a financial and auditing background and before he became engaged in Corporate Real Estate he acted at executive financial management level in various companies including KPMG and Philips. Since the beginning of 2016 he has been a partner with True-Market-Value.com, mainly focusing on clients in Benelux.
Abstract The paper shares experiences and know-how on how to significantly improve the divestment process of Corporate Real Estate assets by better managing transaction risks, reducing the project timeline and
increasing the net sales value. Two Corporate Real Estate executives share their hands-on experience in relating how they refused to accept that real estate transactions could not be more transparent and found the answer thanks to technology. Keywords: transactions, transparency, compliance, monetisation, innovation, performance Allan Kehlet Rieck
INTRODUCTION How much would an additional 5–10 per cent value of your freehold property portfolio mean to your company’s equity? Imagine the smile on the CFO’s face if it were possible to increase sales prices with 5 per cent — or even more — compared to current valuations fully documenting a divestment success and managing transaction risks. That is what can happen thanks to the innovative usage of NegotiAuctions — the process of combining traditional negotiations and digital auctions when monetarising real estate assets. Company history In my role as Head of Corporate Real Estate
Kees van der Linden
Corporate Real Estate Journal Vol. 6 No. 1, pp. 67–74 © Henry Stewart Publications, 2043–9148
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for the Maersk Group, I had divested 15 properties in different parts of the world and often the divestment process was frustrating. I saw a pattern that did not align with the best interests of the real estate seller; even in the most sophisticated markets there were no assurances that we were selling our assets at the maximum price and, as Head of Corporate Real Estate, I was often left doubting whether the true market value of the assets was actually realised in the sales process. Comparables were often outdated, not perfectly comparable with our property; or the data material was weak and not representative of a dynamic, up-trending market. We wanted real time market benchmarks that could be relied on, so that we could rest assured that there was no money ‘left on the table’ after selling corporate properties. Maersk is a company of high ethical standards and combined with a high performance culture, I was simply seeking evidence of a job well done.
Normal Negotiation
Advisors would always claim that a good deal had been achieved, but they could seldom provide hard evidence supporting their statements. On small deals we could maybe accept this ‘black box’ situation, but when selling Prime and Trophy assets worth several millions of dollars, anecdotal evidence would not suffice for me. Founded in this discomfort, we started piloting the NegotiAuction approach — a process which combines traditional negotiations with the advantages of digital auction technology (see Figure 1). This was first tested out on a small scale, but as we became confident about its effectiveness, it was quickly adopted as it was deemed to be the best approach to CRE divestments, and it soon became the default sales process. The University of Singapore has studied the impact of the auction method over a typical negotiation process. Their research found that one could gain up to 9.2 per
Digital Auction
NegotiAuction Optimization
Time efficiency
Dialogue
Fairness
Clarification
Transparency
Investor Screening
Documentation
Relationship building
Common Value
Human touch
Digitalization
Figure 1 NegotiAuction is a new transaction method that combines the best of both worlds: old economy, traditional negotiations; and new economy, digital auction technology. The result is higher sales prices, shorter project duration and full transparency and audit trail
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cent better pricing, and we have often seen improvements higher than the Singapore report’s findings. REGAIN CONTROL OF YOUR TRANSACTION The traditional transaction process has not developed for a long time and instead of embracing technological advancements, it is still a local network business, controlled by local real estate brokers. If one does not insist, they probably prefer to do all investor communication without the seller’s interference. When transacting major values for a company, that is of course unacceptable, and as a minimum CRE needs to be at the negotiation table. But there is no guarantee that all potential investors have made it to the best and final negotiation phase — and therefore there is no assurance that the property fetches the best possible price unless CRE is closely involved in the full transaction process, including the marketing and shortlisting process. HOW MANY MIDDLE-MEN DOES A TRANSACTION NEED? It is difficult, if not impossible, for a broker to take best care of both the seller’s and the buyer’s interest at the same time. Thus it is increasingly common for both the seller and the buyer to engage the services of a broker to help protect their best interests. But is that the ideal solution? Misunderstandings can happen between two people — but now there are an additional two parties in between the two principals, buyer and seller, and there is a significant risk that the messages between the parties can be ‘tweaked’ or miscommunicated. The consequence is that the deal efficiency suffers and optimisation opportunities are lost. The best solution is to deal directly between principals. The result is straight talk and an opportunity to optimise the deal, as
challenges and issues can be dealt with in an efficient and effective manner. Trust can be built between the principals and decisionmaking speed increases. One delicate issue remains, however: the seller wants to sell at the maximum price, and the buyer wants to buy at the lowest possible cost. In terms of price, interests will always be conflicting and negotiations become a balancing act that can drag on for quite some time while parties position themselves for a good deal. The strongest negotiation strategy is to have alternative buyers lined up and to avoid a monopoly situation. This means that the complexity multiplies when several buyers are involved, however. A digital auction is a very efficient and fair way to organise the final negotiations as one can deal with 3–5 parties simultaneously, while giving equal treatment to these parties. And instead of negotiating for weeks, the digital auction is concluded within a couple of hours. WHAT MAKES THE NEGOTIAUCTION PROCESS SO MUCH MORE EFFICIENT? There are two main improvements compared to a traditional sales process. First and foremost, the process recommends that the seller produces Due Diligence material (Vendor Due Diligence) before going to market in order for both the seller and potential investors to better understand the condition of the real estate asset before the value is being negotiated (see Figure 2). The result is less risk, less guesswork and less uncertainty for buyers. This in turn produces a higher quality of indicative bids and weeds out parties who would walk away later in the process (when/if they find insights that constitute shop stoppers for them). Secondly, the process applies digital auction technology in the Best&Final
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Select broker
Marketing
Indicative Pricing
Negotiate with top 2
Exclusive DD
Red Flag negotiation
Closing ?
Figure 2 The typical divestment process creates a lot of risk because the investor has gained an exclusive monopoly and competitive pressure is gone. The final sales proceed is unknown and the process time is uncertain as it fully depends on the investor. Sometimes investor and seller end up not agreeing on the due diligence findings and the entire process is wasted and one has to go back to the drawing board.
negotiation among qualified investors. Now you and your key stakeholders can witness the final negotiation, real time. This means that there is no more uncertainty about the sales price being optimal and you have all evidence at hand (see Figure 3). All in all, the efficiency gains means that the sales process can be concluded within 100 days from putting the property on the market until the asset is sold. You get the sales proceeds faster, you have spent less resource to make the transaction, you have lower carrying costs — and most importantly, you save a lot of frustrations and uncertainty as to when the property will sell. You are more in control of the process and outcome. RISK MANAGEMENT When following a traditional divestment process (Figure 2), the authors have found that it exposed the seller to a great deal of risk and uncertainty, both in terms of final
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net sales proceeds, external costs and timing of the closing. The main problem is that investors often ask for exclusivity early in the sales process. Their argument is that they need to invest in due diligence reports from engineers, lawyers, accountants, etc. But the problem is that exclusivity only works to the buyer’s advantage and should be avoided if possible. If the seller gives in to the exclusivity request, the consequence is the creation of a monopoly situation where the seller is at the mercy of the investor and the company is exposed to a great amount of risk, frustration and uncertainty. The authors’ experience has been that awarding such exclusive due diligence too soon can only work against the seller, because there is a high risk that the investor will gain more knowledge about the asset than the seller. The result, seen even with professional and highly regarded investors, is that they will be able to apply the infamous ‘salami method’ to ‘slice by slice’ reduce the previously agreed sales price that
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Figure 3 The best and final digital negotiation/auction can be fully documented and witnessed by internal stakeholders, in real time. The digital auction starts with the offers received during the NegotiAuction process and investors can stick to their initial bid or participate in the real time bidding. Investors seldom give the best and final in the very first offer and thus the auction brings out the true market values. The investor appreciating the property the most wins the auction and the runners-up have been given a fair chance to win. Every qualified investor has been given equal opportunities and the process leaves a lasting audit trail.
is typically negotiated prior to the exclusive due diligence. The side effect is delays and excessive legal fees to negotiate the final price after the due diligence. In these exclusive situations, several risk are at hand for a corporate. The investor knows well that the selling company is likely to consider the asset ‘sold’ when a price is agreed upon and the exclusive due diligence is initiated. At this point, the seller will typically have disregarded other investors who might have been interested in the asset, leaving the seller with no or poor alternatives. Meanwhile, a significant amount of time has passed since the sales process was initiated, and at this stage it would be costly in terms of financial and human resources to abort the transaction, with the risk of having to start from scratch.
Additionally, resuming the dialogue with any of the previously disregarded investors poses a poor option from a negotiation point of view. Learning that the property is back on the market, other investors are likely to be suspicious and think that there is something wrong with the asset. And so the exclusive investor has been given the upper hand and there is a very good chance that they will exaggerate due diligence findings in order to negotiate a price reduction while bringing negative findings to the table and keeping all the positive findings to themselves. Insiders claim that engineers and other advisors are hired to specifically focus on each and every ‘excuse’ to get the price reduced. The investment manager is financially motivated for making good, below value
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purchases and the investor can be tempted to exaggerate due diligence findings. In one case a professional and well-regarded investor insisted on a 30 per cent price reduction, which seemed unwarranted. At Maersk I would not accept unreasonable demands and sometimes had to walk away from a deal, despite the huge effort wasted. Eventually I discontinued to sell properties by applying the traditional and outdated divestment process. Instead we applied the NegotiAuction process as per Figure 4, where risks are reduced and competition is maintained throughout the process. In summary, in a traditional transaction and due diligence process, risks are monetary in terms of the potential discounts on the sales price that a seller might be forced to accept — or even worse, there is the risk that the investor will walk away if there are substantial negative findings, or if the market fundamentals deteriorate during the due diligence period. If closing is smooth, there is a chance
Vendor DD
Marketing
Indicative Pricing
Interview & Vetting
that the investor knows they did a fantastic purchase, or maybe the market has improved during the sales process and the asset is already worth more than when it was put on the market — and sometimes the due diligence produced positive outcomes that the investor will keep as an additional bonus. CREDIBILITY: BRANDING YOUR CORPORATE REAL ESTATE FUNCTION Besides the financial upside from higher sales prices and reduced transaction costs along with the shorter timeline, your bonus from applying the NegotiAuction process is the positive reputational impact resulting from transparent transactions. Management has come to accept that Real Estate transactions carry an element of uncertainty whether properties are sold at or below value. It has been a matter of trust. While accepting that transparency
Strategize
Best & Final (eAuction)
Confirm atory DD
Closing
Figure 4 A more efficient approach is when the final negotiation is compressed into hours instead of weeks or months. Frontloading some necessary work to better understand the property for sale will reduce your transaction risk and give you control over the process timeline, while increasing and maintaining interest for the property, resulting in more competition and better value. A recognised side effect is much-reduced legal fees, as there are fewer post-due diligence legal battles.
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was not achievable historically, it does not mean that they were happy with this fact and it is one of the few remaining aspects of a corporate that is still associated with so much risk and uncertainty. It is the authors’ experience that credibility and respect for the CRE function is heightened when it is able to shed light on the ‘black box’ of real estate transactions. TEAMWORK: LESS ME, MORE WE Corporates nowadays involve many different stakeholders and expertise in real estate transactions, meaning that the transaction teams can easily comprise five or more in-house personnel (legal, tax, risk, finance, M&A, strategy, management, various CRE members). Hereto comes the external advisors. That is a lot of stakeholders and in a traditional process, not everyone can be at the table during final negotiation. The best way to involve them all in the ‘Best&Final’ is a digital negotiation/auction that all stakeholders can witness personally, in real time, from a conference room at HQ. The documentation of a strong deal is now evident and transparent, and instead of second guessing, management can be assured that the sale gained the best price. Management can even witness the best and final themselves. Now the final negotiation becomes a great team event that can conclude an intensive project on a high note. Now it can feel really good to sell a valuable property and it will have a positive impact on the entire CRE team’s credibility and reputation throughout the company. COMPLIANCE At Philips, Kees sought to perfect transactions based on his background in audit and with an urge to be fully compliant. And even with a thorough transaction process as
described in Figure 4, quite often Executive Management raised the following three questions: • How was the best and most willing buyer in the market selected? • How did the transaction process ensure maximum sales returns? • How was the final sales price achieved ? Internal Audit also repeatedly advised further improvement of the transaction documentation, mainly focusing on the critical decision steps in the sales process. The mitigation of these risks was found in the digital negotiation technology. The digital auction is the purest compliance evidence, as there can be no second guessing about the negotiations and winner award. It provides a perfect and lasting audit trail confirming that the property was sold to the right party, at the right price, thereby alleviating doubt or concern about the divestment transaction. EXECUTIVE SUMMARY NegotiAuction produces evidence of a greater deal The traditional sales process has not improved for a long time, and it is typically more advantageous for investors than sellers. In a buyers’ market that might be unavoidable, but corporate real estate assets are often in high demand nowadays and thus it is time for sellers of real estate to improve the divestment process and make use of modern technology. NegotiAuctions is combining the best of both worlds: maintaining the advantages of the human factor for clarification, optimisation and trust and combining these with the clear benefits from modern technology (digital auctions). In short, the three key advantages of the NegotiAuction process are that:
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(1) it produces greater sales values, significantly above valuations; (2) a 100-day sales process timeline is more efficient for both buyer and seller, catering well for a dynamic world; and
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(3) it produces evidence that all potential buyers have had a fair chance to win the property — and that pricing was optimal; thus it is a vaccine against criticism and second guessing.