Property Asset Management - Case Study Example

Property Asset Management November 21, 2008 Property Asset Management and Market Expansion Del Boy's objective and strategy "Dell Boy has now set itself the objectives of integrating forward into (1) the manufacture of personal computers, (2) distribution, and (3) the retail market. Its strategy is to acquire warehouse facilities and retail outlets." Assessment on acquisition strategy to support expansion It is definite that Dell Boy is expanding to take the opportunity of an expanding demand for computers. Consequently, as a complement to the expansion strategy it now wants to do distribution and opening up retail outlets that it will own. Its need for warehouse facilities will not only be the storage of its raw materials and finished goods but as a possible chain of warehousing hubs that will feed the retail outlets of finished goods. Its choice of location of the retail outlets will most likely determine the strategic location of its warehouses so that logistical support of fast and cheap delivery expenses is maximized. The choice of location of warehouses is therefore crucial and is heavily dependent on their projection of where the retail outlets are to be situated. It seems that leaseholds are long-term and for 30 years. On the other hand their strategy to expand and locate retail outlets are yet to be tested and any error in their choice will mean that they have to pre-terminate their leaseholds, if they go on leasing, or assign them. The existing leases are FRI types which mean that Dell has the annual burden of maintaining the facilities, repair and cover them with insurance. But it saves them to raise the capital cost to set up the facility. In a leasehold Dell does not need to raise the initial cost of constructing the facilities. On the other hand in a freehold Dell will have to raise the required huge funding at the start of the project. In a Leasehold the company does not end up owning the facility and thereby benefit from it increases in value. In freehold they benefit from the gain on the sale of the property at values that are higher than the acquisition cost. The impact on the net income in terms of leasehold costs as against depreciation will be minimal. Leasehold rates include financial charges of lessor, whereas in freehold that is funded by debt the company will incur financial charges as interest and depreciation expense that is over the life of the asset. In both freehold and leasehold with FRI Dell will incur the same cost of annual maintenance and repair, and cost of capital. In Dell's decision to acquire as freehold warehouse facilities and retail outlets chains has an impact on capital investments. There are two types of properties that they need, namely: warehouse facility, and retail outlets. In either case they will also need transport delivery system, between the plant and the warehouse, and from warehouse hubs to the retail outlets. Capital asset investment. Definitely, the freehold strategy will require huge long-term funds. The location and number of square meters will determine the acquisition price of each type of facility. In the case of warehouse facilities their location will likely be outside commercial centers may not be as expensive in terms of property values compared to retail outlets which are to be located in commercial centers where property values are higher. Also, the retail outlet and location of property will likely increase in value over the years compared to warehouse locations. In terms of the size or area required the warehouse facilities could be larger on the average compared to warehouse outlets. Their current cost of acquiring could be the same with the outlets of higher price per floor area but less area, while the warehouse is with a lower price but larger area. But when the total areas of warehouses and retail outlets are compared the investment on each type that is needed to acquire them could be significant. We do not know which one will be more expensive when the aggregates are computed. Financing source. With a huge capital requirement on freehold strategy Dell will either source the financing through its own cash generation from operations, issuance of shares, or a long-term debt instrument like bonds, or borrows directly from banks. Or the financing will be a combination of any or all of these. It is assume that in the funding the return on investment is desirable given the incremental income from expansion. Alternative strategy The advantage of leasehold is the avoidance of initial capital investment and sourcing of funds. In leasehold the asset is immediately available for use, unless there are major repairs that the lessor will have to undertake before it is turned over to the lessee. Strategic partnerships. There are alternative strategies in the strategy to go on retail outlets through leasehold. Other than freehold is the possibility of partnerships with well located and already existing retail outlets that are willing to include Dell computers in their product line. This will reduce promotional costs of introducing the location of dell computers that are in dell outlets because the computers are already inside outlets where people go to shop other goods. In a sense Dell will ride on the outlets name and image. There are many retail outlets that are not operated by the manufacturers although they carry other computer brands. Of course the discount to be granted to the retail outlet should not be far higher than the annual cost of freehold. Core competence. A retail operation is a new ballgame of Dell. Dell should stick to its core competence. It is perhaps better to leave the selling to the existing retail outlets and benefit from their merchandising expertise. Dell can concentrate on distribution and manufacturing. Dell USA does not use retail outlets. It sells directly through internet orders. It outsources the assembly of the product based on customer specifications. Leasehold with option to buy. If the leasehold includes the land Dell can request for a leasehold with option to buy at a pre-determine price at maturity of the leasehold. This will provide Dell a chance to benefit from the increase value of the land at the end of the leasehold period. It is also possible to go on leaseholds on warehouse facilities. It is likely though that Dell prefers to own and operate the warehouse to ensure that the finished goods are safeguarded and only Dell products are inside. There will be less of these compared to the number of retail outlets to operate and own. Inherent characteristics of freehold There are many advantages of freehold strategy. Freehold has a definite advantage of the benefits of an increase of value of the land in the future. If the location is successful in serving the needs of the market because it turns out to be the right location then the company has achieved the objective to be there without the worry of looking for another location later or to renegotiate a new leasehold. There are no restrictions on any changes in the contour or design of the property when necessary. There are disadvantages. There is the cost of raising capital at the initial year. The equity earning per share may be diluted as the immediate effect of funding through share issue if the market and net income projected are slower than projected. This may affect the value of the shares. If funding is externally source there is the burden of maintaining the debt equity ratio of the firm that the banks or lenders will require. Comments on Dell maximizing on property exposure through freeholds. Broad guidelines in freehold acquisitions. This subject is partially covered in the immediately preceding section. There are advantages and disadvantages in freehold strategy. The broad guidelines in this strategy are as follows: The most important consideration in any asset acquisition that is to be used in operations, particularly as retail outlets and distribution and storage centers is the right selection of the location. The choice of location should give the company the greatest benefit on market penetration, lesser cost of maintenance and shipping costs, and personnel. The objective is not only on market share but also on the resultant effect on the value of the firm and shareholders' interest. The second consideration is the amount required for initial funding. The cost to the company in terms of the impact on the shareholders' shares in dividends per share or price per share price of its shares in the market The third consideration is the enhancement of value of the asset and its salability in case it is disposed. The fourth consideration is the zonal restrictions on the property that is imposed by the neighborhood or by law. The fifth is the nature of payment. One approach is to swap the property with corporate shares that are already in treasury or on new issues. The latter will require a lot of procedures to follow. The sixth is the nature of the bond or preferred issues in case that is the avenue in raising capital. There might be a need for sweeteners in the form of convertibility of the debt to equity shares. The seventh is the flexibility in disposing the equipment without much loss or time to dispose. What to do with the two existing leaseholds There is a one year time gap between the start of full operations of the new plant and the expiry of the existing leasehold. Assuming that the location is right the company should negotiate for a purchase. Otherwise, it must relocate. Since the asset is for a warehouse then the impact on sales will not be very large if the company relocates. Buying it and to be idle for one year will cost the firm the financing cost for one year if funded from debt. If acquired with funds from operations, say cash reserves from retained earnings, then it is not so costly except the reduction of working capital. If the lessor is not willing to sell, then the company can negotiate with a lease with option to sell. Failing that the company should relocate and charge to expense the cost of the leasehold for a year. Or it can continue to use it for current warehousing operations without renovating the dilapidated property. It can tear down the warehouse and charge the cost of razing the property to current operations as a tax shield. As to the other asset that will still expire five years from now. The plan of the company to assign it now, if it is not being used for operations, is sound. It will relieve it the burden of absorbing the cost of leasehold annually. It can later on negotiate with the lessor as in the first property. Financial statement presentation. In the balance sheet freeholds that are not used in operations are classified under investments in property and not in property and equipment. The company should take review the portfolio of its investments and see which ones are giving the desirable return on investment. The property that is for the new plant can be an exception. But it should be considered as a cash outflow in the evaluation of the return on investment on the expansion project. Management should watch the financial indicators that potential investors normally use in assessing and valuing the firm. Among others this includes the long-term solvency and return on investment. The new funding may have a huge negative impact on the investor. While on the other hand the potential of growth is there these do not show in the published financial statements. They are at best only projections. Major decisions. The decisions on the acquisition of the warehouse and retail outlets facilities are major decisions that have a long-term effect on the company. This is particularly important because of the impact of funding on the value of the shareholders' shares. While the impact on the announcement of expansion is a positive for potential investors the manner of sourcing the funds will also affect the market price. If the bulk of investors are retirement funds that need cash dividends then the company should consider that when it uses cash generated from operations to finance the new facilities. If a convertible debt issue or preferred share issue is contemplated then management should consider the dilution of earnings per share at the time of conversion. Management can mitigate this by scheduling the annual or periodic conversion dates of the instruments to be issued, or to make it at company option to redeem with conversion. This is a matter of timing and can be decided at the appropriate time. In a debt instrument like real estate mortgage there is usually a provision of the lender that the interest rate is floating or flexible and will be adjusted from time to time. This again is something to consider on this type of funding source. One aspect for management to consider is the level of inventories to maintain in the warehouses and in the retail outlets. It should install an effective data base system for inventories so that overstocking in one warehouse or outlet is minimize by drawing from high levels to supply current needs of retail outlets. This will reduce investments on finish goods inventory. The training and recruitment of new employees to employ in the retail outlets is also crucial. Marketing and operating retail outlets are not the core competence of Dell Boy. Development of the market through these outlets will take time considering that it will likely move into markets where there are already existing competitive products. This will not only require promotional costs and efforts but people. The company can outsource the promotional task to experts and in the business. But training people is a different matter. References: "Buying Leasehold Property", http://www.mortgages.co.uk/buying-freehold/index.html "Chapter 6 - Investment decisions - Capital budgeting", FAO Corporate Document Repository, http://www.fao.org/docrep/w4343e/w4343e07.htm "Freehold", http://en.wikipedia.org/wiki/Freehold Read More