Private Equity Firms’ New Tack

By T. Bradley Fulkerson III, Managing Director, Transwestern: Private equity and venture investors are taking a different approach to real estate transactions.

Fulkerson, BradleyThe rippling global effects of China’s economic slowdown and slumping valuations for many private equity and venture-backed companies are prompting investors to seek a more strategic approach to one of the largest costs for any business: its real estate footprint.

Private equity firms gravitate toward a strategic, consultative approach to real estate that’s driven by the same sorts of tools (such as stochastic modeling and neural networking) that they use in assessing the valuation and potential of their portfolio companies and prospects. It also gives them greater confidence in approving the capital required to relocate to a new space, renovate existing space to make it more functional and commit to the long-term costs of occupancy.

Those sophisticated forecasts, and the sound logic behind them, can also expedite negotiations with a landlord to reach a mutually beneficial transaction. That’s especially true when you take the time to gain a deep understanding of the landlord’s financial objectives and goals.

Transwestern recently worked with a payment processing company that wanted to open an Atlanta office. Initially, the company’s management thought it would have a couple dozen employees for a few years and that a modest short-term sublease would be sufficient until it had a better understanding of the company’s long-term needs.

As we studied the situation and the company’s financial objectives and growth trajectory, it became clear that relocating its U.S. headquarters to Atlanta from the West Coast and consolidating locations was an optimal solution that would help the business grow.

We worked with management to refine its headcount and challenge assumptions, and ran simulations that stochastically modeled thousands of iterations to show that the headcount was highly likely to exceed its projections. Our models helped management decide, with great confidence, that it needed more space to accommodate that growth. We determined it needed a full floor of space, and that the economics of a 10-year deal were far superior. We structured a lease with double the tenant improvement allowance you’d typically expect to see, which let our client design an open space with flexible work stations, comfortable booths for small meetings, collaborative areas for team huddles and a game area to break up the workday and get creative juices flowing–primarily funded by the landlord concessions.

This is a long way from the mentality of just a few years ago, when fast-growing companies were flush with cash from private equity and venture investors. As these investors refocus on the fundamentals and core costs of their portfolio companies, there is renewed interested in a more scientific approach to real estate transactions and creating elegant deal structures that satisfy each party’s financial targets, constraints and aspirations.

Done well, it can have the dramatic effect of changing real estate from a cost center to a business enabler and value creator.