3 Scenario Planning Strategies to Optimize Your CRE Portfolio

A CRE portfolio exists in three different blocks of time. You sign your leases in the past, you occupy spaces in the present and they need to serve your business’ needs in the future. Balancing these three time spans can be challenging for a portfolio manager. However, applying traditional tools from the fields of risk management and scenario planning can help to create a portfolio that meets your organization’s needs now and in the future.

Future Planning with Scenario Planning

CRE portfolio management might not seem like a blue sky industry. Generally, managing a company’s real estate assets is a nuts-and-bolts endeavor, focused on leases, CAMs and operating expenses. However, given the forward looking nature of leasing, signing a document without first going through a scenario planning exercise could lead your organization to lock in a space that becomes a white elephant.

Many things can happen with a space over time. The hope is that it will be such a successful location for you that you rapidly outgrow it. If it doesn’t work out well, you could end up needing just a fraction of it. The focus of the community in which it is located could shift – today’s hot office market could become tomorrow’s Class C backwater. Scenario planning lets you look at a space and an area, determine where changes could occur and project their impact. Based on the scenarios that you feel likely, you can create different emphases in how you sign your lease. Here are some of the strategies that scenario planning can help you:

• Request rights of first refusal for spaces adjacent to a premises that you might outgrow.

• Select a subdivisable space if you project a risk of your need shrinking.

• Sign a shorter lease if you anticipate an area’s inherent nature changing.

Managing Rental Risk

While scenario planning can encompass the process of identifying future risks, it doesn’t necessarily work to manage them. The best way to manage your CRE portfolio rental risk is to negotiate a shorter lease with more options. A ten-year lease with two five-year options gives you 10 to 20 years of relatively risk-free occupancy, since your landlord won’t be able to evict you and the terms of your renewal are predetermined. The biggest risk is that you’d stop needing your space before the 10 year initial expiration date.

A five-year lease with four five-year options gives you even more protection against the rental market. You gain control over the space for up to 25 years, if you want it. On the other hand, you can move out after just five years. This increases the flexibility of your CRE portfolio and decreases the risk that you’ll be stuck with a space you don’t want or need.

Risk Sharing Approaches

One of the fundamental principles of risk management is that you can control your risks by sharing them. Here are some strategies that allow you to transfer risk to other parties, making your CRE portfolio a safer financial bet for your company:

• Choose to lease space instead of owning it. This transfers the large risks of vacancy, capital expenditures and obsolescence to the owner while leaving you with a manageable risk of rental increases.

• Sign full-service gross leases that transfer OpEx liability to the landlord. If possible, replace tenants that are less efficient than you.

• Occupy smaller spaces with rights of first refusal on adjacent ones. This way, you control expansion space without paying for it.

• Operate multiple, smaller locations, reducing the impact that a problem at any one space could have on your CRE portfolio as a whole.