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I. Executive Summary: Holt Lunsford Commercial
The case study titled “Holt Lunsford Commercial” explains how Holt Lunsford is debating how to grow his Dallas-based commercial real estate services firm and how to advise a long-time client who is wondering whether to lease or buy an industrial warehouse. The case focuses on the highly competitive and increasingly institutionalized $50 billion real estate services industry, which encompasses property management, leasing, tenant representation, and other activities. What makes Lunsford’s firm, The Holt Companies, special? The article explores what corporate strategy Lunsford should choose for his firm, and what recommendation he should make to his client.
Holt Lunsford Commercial provided property management, leasing, development, and other real-estate related services to owners and tenants of industrial buildings. By 2003, Lunsford was responsible for management or leasing of over 27 million feet of property, and it employed over 50 people.
Staton Tees, a wholesale T-shirt distribution business, had called Lunsford seeking a solution to its space needs. Staton’s lease of Welch Center, the 100,000 square-foot warehouse/office property that served as headquarters for Staton Tees, was due to expire at year’s end. Staton wanted to know if he should renew the lease or perhaps pursue other options, such as buying the property outright or even developing a build-to-suit facility. Lunsford had previously negotiated several lease on Staton’s behalf, but had yet to help Staton purchase or develop any facilities, so their lunch meeting could ultimately expand their business relationship.
Lunsford met Stanton, the T-shirt distributor, while working for Trammell Crow. The relationship started with the two men on opposite sides of the table, but soon developed into a close relationship enjoyed by both families. When Holt Lunsford Commercial first opened its doors, Staton asked Lunsford to handle tenant representation duties for this T-shirt distribution business. Although tenant representation would not be the major focus of Holt Lunsford Commercial, Lunsford happily agreed to Stanton’s proposal, and Stanton Tees became his first client.
Staton should continue leasing the Welch Center, rather than buying this building or pursuing a build-to-suit new building. First, leasing would give Staton much more flexibility in short to medium space needs and Staton did not anticipate any immediate changes to his logistics and distribution processes. The T-shirt business like the apparel industry as a whole is very dependent on customer demand. Thus, if there was a global or domestic economic shock, demand for all apparel, especially T-shirts, would sharply decline. Leasing would provide the flexibility to contract or expand according to the market demand. Define the central issue
Staton’s lease of Welch Center, the 100,000 square-foot warehouse/office property that served as headquarters for Staton Tees, was due to expire in nine months. The owner of the building had indicated a desire to negotiate a lease renewal, and had also offered to sell the property to Staton. But if he wondered if he was going to own his headquarters, perhaps he should simply develop a customized built-to-suit facility.
Who are the key players and give their backgrounds briefly? Holt Lunsford is Founder and Chief Executive Officer of Holt Lunsford Commercial (HLC), a commercial real estate service and investment company founded in 1993. HLC’s core lines of business include development, leasing, property management and investments in the office and industrial sectors. They manage and lease a 44 million square foot portfolio of buildings in Dallas, Fort Worth and Houston for private and institutional owners.
As the HLC service platform has expanded, Holt has led the firm into the investment arena through development and acquisitions of property in Frontier Equity. The firm’s market reconnaissance and on the ground professionals are the key assets to inform sound underwriting and execution on the investments made. This model has facilitated the development or acquisition of over eight million square feet of product since 2003.
Staton Tees, a wholesale T-shirt distribution business, was founded in 1981, in Baton Rouge to service the emerging T-shirt printing industry. By 2003, Staton was the largest distributor of Hanes products and generated over $200 million in total sales. In 1993, Staton moved the firm’s headquarters to Dallas. In 1993, Staton asked Lunsford to handle his tenant representation business. Lunsford’s team in Dallas handled tenant representation work outside of Texas for Station.
Explain the supporting data Real estate occupancy costs represented about 4% of Staton’s cost structure. With a central location in the southwest United States and excellent thoroughfare systems, Dallas had become a major distribution hub for the flow of goods to the customer. The city’s demographics and legal/regulatory frameworks made it an attractive market for corporations needing industrial space.
Identify the constraints to the problem Welch Center was a 102,718 square-foot front-load, dock high industrial bulk warehouse, with a 24-foot ceiling floor to joist. The building had a concrete truck court (120 feet) and 107 parking spaces for employees. Inside there were approximately 15,000 square feet of office space on the ground floor dedicated to the firm’s corporate headquarters, call center, and customer pick-up area. The building was in good condition, except for the roof, which had an estimated remaining life of 5 years. Roofs cost were traditionally $2.50 per square foot to replace. The center also featured slightly above average column spacing. Welch Center was considered a Class A building, and if fully leased at market rates, might fetch between $34-$40 per square foot, on the open market.
Evaluate alternatives to the central issue Lease-renewal option Lunsford estimated the market-lease rate for Welch Center to be $3.35 NNN per square foot, upon renewal. The operating expenses would add an additional $1.15 in year 1, so the total expected occupancy costs in 2004 would $4.50 per square foot. Leasing had several benefits for owners like Stanton. Many companies chose to lease space and treat the expense as an operating cost, while focusing assets on their core product or service offering. Staton could sign a 3-year rental agreement with a renewal option, providing the ability to grow or contract in the short to medium term if the business hit rough times. Staton had considered changes in standard fulfillment processes, along with new technologies and equipment, but he did not anticipate any immediate changes to his logistics and distribution processes.
Buy Option The owner had expressed a desire to sell the property for $34 per square foot, or $3,492,400. Lunsford estimated the required equity to be $873,100 assuming 75% leverage and a loan of $2,619,300. Including legal, engineering, and closing costs along with the origination fee on the loan, Staton’s total out of pocket expense could be as high as $943,100, although Staton was not overly capital constrained. Bank debt was less expensive than permanent financing from other capital sources, but typically was full recourse, and thus would require a personal guarantee from Staton. A pre-payment penalty equal to 1% would be applied, if Staton paid off the loan during the first four years of the interest-only 5 year not. It was debatable what the highest and best use of Welch Center would be after 10 years; however, to determine expected residual value, Lunsford estimated a year 10 inflation-adjusted rent of $4.24 NNN and assumed a 9.25% exit cap, along with 2% for closing costs. Staton wanted to know if owning Welch Center could surpass the 20% pretax return on equity he received through Staton Tees.
Build-to-suit Option Lunsford had identified a 315,000 square-foot parcel of land in Colon Crossing area, 20 miles north of Dallas, on which Lunsford could develop a 110,000 square-foot facility. The land would cost $3 per square foot, making the effective land cost $4.59 per square-foot of building, given the 35% coverage ratio. Total construction costs not including land, would be $26 per square foot, with $4 per square foot in soft costs plus the developer fee. Lunsford estimated that he could build a 28 foot-clear warehouse in six months. Lunsford believed he could help secure similar financing arrangement to the one he suggested for Staton’s possible purchase of Welch. With a strong tenant like Staton, Lunsford said he could easily recruit one of his institutional investor clients to cover the $951,250 in equity. He told Staton he would likely need to commit to five-year lease a $3.30 NNN/SF rent in return for the new customized building.
Make your recommendation(s) I think Staton should continue leasing the Welch Center, rather than buying this building or pursuing a build-to-suit new building. First, leasing would give Staton much more flexibility in short to medium space needs and Staton did not anticipate any immediate changes to his logistics and distribution processes. The T-shirt business like the apparel industry as a whole is very dependent on customer demand. Thus, if there was a global or domestic economic shock, demand for all apparel, especially T-shirts, would sharply decline. Leasing then provides the flexibility to contract or expand according to the market demand.
However, if Staton owned the Welch center or built a customized building, he would still have to pay the debt and operating expenses on a building that may either too big or expensive given the demand for Staton’s products. Furthermore, developing a new headquarters could become very distracting to Staton’s focus on its core business, producing T-shirt economically and quickly for its customers. If Staton does not believe that the existing center is not outdated, then there is no economic or business justification for tying up his company’s equity by owning real estate. Finally, Staton would have to use leverage on either own scenario, so he should think carefully if wants to an additional risk to his business, making the required debt service payments. Finally, if Staton does decide to lease, he should make his lease renewal contingent on the owner replacing the existing roof on the Welch Center at his expense.