Real Estate As Earning Assets: The Other Side Of The Story

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I read with interest your facilities feature articles (CUJ May 14). Good information.

One article caused me some concern. It was titled "CUs Can Transform Non-Earning RE Assets Into Earning Assets" by Vincent Pellerito. While banks and credit unions can harvest the value they have built in real estate to spend on growth and more liquid investment initiatives, they must also understand what they are giving up. There is another side of the story which should be shared with credit unions.

If owning real estate assets was not profitable, would so many institutional and private investors be flocking to purchase financial institution real estate and lease back to a solid tenant? The answer is no. While real estate may not be showing a book return every quarter, appreciation has been substantial over the years. If a credit union sells its branches and headquarters to others, they have lost an asset that produces significant return over time in terms of cost savings and potential sales value to fund continuing growth and evolution.

One of the biggest losses is control of a credit union's physical environment. It is owned by someone else who has significant rights in the building's operation. Leasing has two other major downsides: 1) loss of long-term rent control which causes rents to fluctuate with the market and generally escalate. While with ownership, the rental cost is based on the investment which is fixed in time unless subsequent remodeling has occurred. 2) loss of significant appreciation. A credit union that owns a 30,000 square foot facility and needs a 60,000 square foot facility to meet future operations needs can sell its building to fund the next level of occupancy. If the 30,000-square-foot building sells for $200 per square foot or $6 million, the credit union must only come up with another $6 million for a building twice as large. Without ownership of the building, the credit union would need $12 million or sign a long- term lease for a $12-million building with an escalating cost basis.

The cost of funds is less for a credit union than they are for a developer. A developer must cover their interest payments and make a profit which can often double or triple the funding cost for a project and increase the cost basis for rent.

A good example of why credit unions should consider ownership is the value of retail branch land. Many credit unions are finding that if they purchase branch land ahead of need by a few years they can acquire the land for half the price. This significant cost saving is being repeated across the country by many of our clients. As an example, a 40,000 square foot site in a young retail market may sell for $12 per foot or $480,000 and then three to five years latter sell for $900,000. This is not an unusual scenario. If a credit union leases this property and a building from a developer, the cost basis for the land is $900,000, not what the developer paid for it. The resulting delta can produce big cost savings for a credit union over time.

I agree that it is less expensive to lease over purchase, but only for the first six to seven years. Past seven years it becomes increasingly less expensive to own and the credit union is building a substantial asset. This means that when a credit union is developing its financials, they must extend the cost/benefit analysis past five years to 10 or 15. When developers purchase property, they look at immediate return potential, but more importantly they calculate the high return over time (10 to 15 years).

In our consulting work we advise our clients to purchase, sell or lease properties, based on the short-and long-range financial and growth goals of their credit unions. There are times when a credit union should lease and times to own. When considering lease versus own for properties with long-term location value, every credit union should think in terms of five-ten- and 15-year ROI.

While the purpose of credit unions is not to invest in real estate, running a credit union is both a service to members and a business that should be profitable and thrive, not just in the short term, but over the long term as well. Each board member and CEO should consider the legacy they are creating for their credit union and those that will follow them. Over the past 25 years in the financial industry I have heard this sentiment from board members and CEOs hundreds of times: "I am so glad we purchased that property many years ago, it is one of the factors that holds down our operating cost, makes us successful today and provides the potential resources to continue our growth and prosperity."

Today it is becoming increasingly difficult to purchase great sites at reasonable prices due to demand from a wide range of retailers and developers. If you're not pioneering in a market, you likely have to pay high retail prices. Every credit union pursuing property should don both developer and credit union hats. If the credit union does not have the skills or feels that it will get taken advantage of, they should find a third-party consultant who has significant experience and can help them through the wild lands of real estate leasing, acquisition and development. There is a win for credit unions in both leasing and owning, the key to success is applying short term real estate tactics within a structure long-term vision of prosperity.

Paul Seibert, VP of Financial Services

EHS Design, Seattle


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