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.

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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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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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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

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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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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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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/robert-

knakal-massey-knakal-real-estate-commercial-real-estate-values-new-york-

commercial-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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