Understanding the Opportunity Costs of Vacancy

What is an acceptable level of vacancy in an organization’s real estate portfolio? Corporate Real Estates (CREs) in high-growth companies might say 15% sounds reasonable; after all, optimizing business flexibility is a priority for CRE departments and empty seats enhance maneuverability, accommodating normal personnel “churn” or future growth. Contrast that with CREs in more established, low-growth companies, who likely focus on maintaining much lower vacancy rates.

CRE has to balance flexibility against cost. Metrics, like cost per square foot, vacancy rates and cost-per-seat are closely tracked, and they’re utilized to inform senior leadership’s location strategy, expansion and/or consolidation decisions. So it borders on astounding that while virtually every organization knows its vacancy rate relatively few place a dollars-and-cents cost on that vacancy.

The question - What is my vacancy costing me? – is as fundamental as the answer is critical, yet that question too often goes unasked,  even though the answer brings stark, bottom-line clarity to any assessment of portfolio performance. Moreover, it’s simple math.  That math will show that an organization with a vacancy rate exceeding 10% is likely paying jarringly high, unnecessary costs – sometimes millions of dollars annually - for unused space and needs to ask, “Is that cost of flexibility worth it?”  

Many CREs would answer, “No”. They view it as leaving cash that could potentially return value to the organization sitting on the table. The question they ask is: “What is the Opportunity Cost of that flexibility?”
Not surprisingly opportunity cost means different things to different organizations, depending on their perspective. For instance:

  1. For a company with low churn and little or no growth, carrying a high vacancy costing it $5M per year, the opportunity cost could be the return that cash would earn sitting in an investment. Or perhaps that money could otherwise be dedicated to capital expenditures to increase production volumes and increase revenue, or it could be used for hiring to meet new market demands. 
  2. For a company with high churn and low vacancy the empty seats may be costing them less, but the business may incur additional costs to secure swing space or to reconfigure space - all of which could be money spent elsewhere.
  3. For a company with high growth and low vacancy the lack of space may not prevent it from adopting a seat-sharing policy or forcing personnel into conference rooms, etc., but what if it’s confronted with a huge hiring need to meet a new product demand in the market?  The company may be able to acquire new space in that market, but what if the workforce is tuned to a specific geography with little or no space availability? This situation may lead to an ad hoc portfolio of multiple locations acquired under different market conditions, multiple leases, functional inefficiencies and duplicate systems.

The bottom line is opportunity cost scenarios are unique to every organization. For example, a New York-based business may want to move part of its operations to where a more affordable, equally qualified workforce lives. While the flexibility to hire in a less expensive market and lower cost of labor is certainly desirable an unintended consequence - increased vacancy in their very costly New York location – becomes a sobering counterbalance. Knowing exactly what that vacancy will cost adds a new dimension to what seems to be an easily justifiable business decision.

Seeing the calculation in black-and-white tends to be a real “ah-ha” moment for corporate leadership as they formulate growth projections and make strategic decisions regarding future action on lease renewal, managing the cost of long-term leases and/or business-owned properties. For CFOs it associates a cost to portfolio flexibility, enabling them to weigh that risk in context of the other enterprise-wide financial decisions they’re making.

Determining a threshold for vacancy and calculating the cost associated with it should be - at minimum - part of an annual portfolio strategy review. The fact is, whether vacancy spikes due to a major event, like a merger or acquisition, or it’s a gradual trend over the long-term most companies have more vacancy than they need, and it’s costing them real dollars.

Ann Tucker
Senior Managing Director


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