Property Management – Calabasas

A principal goal of corporate management is to make a business worth more than the cost of its underlying assets. To create such shareholder wealth, management has three levers at its disposal: asset efficiency, operating efficiency, and capital efficiency.

Asset efficiency is the ability to limit the amount of assets that have to be funded with shareholder equity. It primarily entails managing fixed asset costs and working capital levels. Operating efficiency is the ability to improve operating profit margins, which is accomplished by finding ways to increase sales, raise prices, and control expenses. Capital efficiency is the ability to reduce the weighted cost of debt and equity capital. Managers must harness equity in concert with various forms of outside capital to lower corporate costs of capital.

Combined, the three efficiency levers work together to generate shareholder returns. Companies that can produce the highest returns with the least financing drag on cash flows tend to create the highest percentage gains in shareholder wealth, not to mention higher current equity cash flow yields.

The Role of Real Estate

The decision to lease or own real estate is centered on capital efficiency, which is measured by pretax rates of shareholder return. To be sure, there are tax implications to real estate financing decisions. The benefits of real estate depreciation, which can shield income from taxes, can be alluring. However, such benefits are nominal, since buildings are depreciated for tax purposes over a lengthy 31.5 years, and land has no depreciation.

Moreover, the tax benefits are merely a tax deferral, since real estate sold after a long holding period is subject to gains from the recapture of accumulated depreciation. The many public companies that are shackled by the potential for severe tax consequences from imbedded real estate gains serve as a reminder that the better route is to focus on pretax equity return maximization.

Equity rates of return cannot be properly computed from a financial statement: They are a financial, as opposed to an accounting, concept. If a company invests $1 million into a building and finances 70 percent of the cost, then the percentage of equity is 30 percent. The equity percentage never changes unless the debt is paid down, in which case the mix of debt and equity shifts. This is what happens when real estate is owned and related mortgage debt is repaid. As the percent of the real estate funded with loans declines, the amount of equity rises, which has an adverse impact on shareholder equity returns over time.

Apart from depreciation, there is a second allure to real estate ownership, which is the potential for appreciation. Without question, this is a subject worth considering, but not in concert with the proper means of corporate capitalization. Business leaders are rewarded first for focusing their attention on optimizing the three corporate efficiencies. Real estate appreciation, which is a part of real estate returns, is not a business activity; it is an investment activity. The attractiveness of real estate as an investment for companies will be addressed later in this article.

Computing Equity Returns

The V-Formula is a simple shortcut to compute current pretax equity returns. The formula harnesses all three of the corporate valuation levers.

The financial model based upon the V-Formula illustrates the impact of real estate financing decisions on corporate valuation. The V-Formula calculates pretax rates of return on equity, which means that the relative return comparisons are the same, irrespective of the dollar values of the real estate and business. That said, the model assumes location revenues of $1.5 million for the purposes of demonstrating the magnitude of the capitalization decisions on corporate cash reserves.

From CCIM.com by Christopher H. Volk

Carnahan Property Management services Woodland Hills,West Hills, Calabasas, Canoga Park, Tarzana, Reseda, Topanga, Encino, Northridge, Van Nuys,North Hills,Chatsworth, Sherman Oaks, Studio City, North Hollywood, West Hollywood, San Fernando, Granada Hills, Mission Hills, Simi Valley, West Lake Village, Agoura,Toluca Lake, Valley Village, Burbank.