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Ranked #7: Occupancy & Construction Costs

The importance of Occupancy & construction costs, which ranked seventh in Area Development's Corporate Survey, varies according to facility function.

Aug/Sep 06
The cost of building and occupying space is one of the most visible site selection factors. However, this is more easily controlled than the cost of labor.

Project specifications direct construction requirements, and local market dynamics can demonstrate large differences in construction, leasing costs, or land prices. Decisions about reuse of surplus space, space standards, building efficiency, buildout allowances, and the construction delivery method all influence occupancy costs. Then of course there is the art of negotiations and resulting incentives and concessions.
That said, occupancy and construction costs can be critically important - or of little driving significance - in site selection decisions, depending on:

    • The type of project;
    • The geography of the search; and
    • The project's place in the corporate real estate portfolio.

The Type of Project
The importance of occupancy and construction costs in the site selection equation varies significantly with the facility function and degree of facility specialization. There are about as many building types as there are breeds of dogs, and huge variations in specifications and costs.

Offices: A good general rule of thumb for office projects is that occupancy costs represent about 10-20 percent of overall geographically variable operating costs. Most of the costs are work-force-related. A distinction is often made between front-and back-office functions. For back-office projects, generally more sensitive to costs than client-facing operations, site selectors typically seek generic space with standardized low fit-out requirements. Client-facing corporate functions, including headquarters and sales offices, are normally in higher-priced, better appointed space with more bells and whistles. Image and client access often outweigh the costs of fitting out this space.

Distribution centers: Distribution centers typically have low occupancy and construction costs compared to total project cost, and transport- and inventory-related costs obviously take on much greater weight in the total operating cost equation. Customization such as super-level floors, mass refrigeration or highly automated inventory systems obviously adds to cost.

Manufacturing facilities: Manufacturing project costs vary greatly depending on the complexity of the facility, size, and impact of the project. For some assembly and manufacturing processes, a standard building shell will accommodate equipment, machinery, and product flow in a general class industrial park environment. As processes become more sophisticated, specifications become more complex, and where there is an environmental impact, construction costs increase proportionally. In these circumstances, site acquisition, land preparation costs, permits, and specialized engineering and construction can contribute significantly to budgets.

The degree of facility specialization will have a bearing on the site selection equation. For laboratories and complex or advanced manufacturing requiring cleanroom environments, for example in the life sciences and semiconductor industries, construction costs become a key project driver. In one recent case, a super-clean room requirement became the top construction cost factor, accounting for 50 percent of project start-up costs. Specialized foundations and interior construction add significantly to costs for vibration-sensitive manufacturing processes. Even in office environments, specialization counts. Executive suites, corporate conference centers, and high-profile and distinctive architecture also add to the cost equation, though there is a trend away from landmark, high-profile offices and corporate campuses. Over-customization reduces resale and subletting potential.

The Geography of the Search
Is the search area local, regional, or national? Is it onshore, near-shore, or offshore? Is it urban, suburban, or rural?

Construction costs vary widely, influenced by competition for construction resources and labor, the length of the construction season, local design standards, real estate market custom, and other factors. Leasehold costs vary according to local supply and demand in desired submarkets, the provision and quality of amenities, the image of the property, access to employees and markets, visibility or access along major transport corridors, and developer subsidies passed on to tenants.

The above are typical considerations in the United States. Rules of thumb for offshore? Occupancy and construction will be more expensive, with a higher proportion of geographically variable costs, longer lead times, and less room for negotiation. In some of the major offshore destinations, for example India, it is also important to plan for additional infrastructure investment and support, as the infrastructure beyond the site boundaries often deteriorates rapidly.


The Project's Place in the Corporate Real Estate Portfolio
Real estate is a significant balance sheet item and a major contributor to enterprise costs. After labor costs, occupancy costs are often the next biggest bill. Many opportunities to cut real estate costs are overlooked. It is essential to take a total portfolio perspective when selecting a site. Consider the following portfolio cost-reduction opportunities:

Optimizing capacity: Does the company have surplus, appropriate space in its property portfolio? Review the trade-offs between using existing space versus greenfield solutions.
Alternative work placing: Can you leverage technology? Hoteling and telecommuting can often reduce space requirements without reducing headcount.
Efficient space allocation: Are space standards consistent across the organization, and can square footage per person be reduced without compromising the work environment while promoting team collaboration? Is the configuration efficient or a waste of rentable space?
Maximizing asset value: Sometimes the market value of a property is significantly greater than book or utility value. Selling the site and moving the operation can then be a source of cash.
Other financing techniques, such as a sale-leaseback arrangement, can also reduce upfront cash outlays.

In summary, the relative importance of occupancy and construction costs as a site selection factor depends on the situation. While nearly always an obvious and visible component, real estate may be the most variable of the major cost categories of site selection, being an afterthought in some situations.

The efficiency of how organizations make decisions also comes into play. In highly decentralized organizations, business units, rather than corporate real estate departments, may spearhead location projects and site selection decisions. The centralized corporate real estate team may eventually have to face a hodgepodge of inefficient space and long-term commitments. Inefficient planning, use, and administration usually result in underutilized properties and excess real estate costs. Companies that align location facility decisions with broader corporate strategy and enterprise cost management objectives represent the gold standard. In these organizations, business unit leadership works hand in hand with the corporate real estate and workplace team to plan and implement location strategy and project-specific site selection.

Larry Moretti is a senior team member of Deloitte's Global Location Strategies and Corporate Real Estate practices. He has over 20 years' experience working with corporate clients on workplace location and facility portfolio issues around the world.

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