January 19, 2010

CUES' Credit Union Management's online-only "Facility Solutions" column runs the third Tuesday of every month. In each installment, author Paul Seibert, CMC, answers a question posed by a CU leader during research for CUES Complete Guide to Credit Union Facilities.

Q: Should we own or lease our facilities?

Some credit unions say they will only occupy buildings they own because the non-profit advantage makes ownership more financially sound than leasing. Other credit unions would rather lease their facilities and reserve capital to pursue retail delivery through technology and save for a rainy day—or even a monsoon, as we have recently experienced. The right answer to the question of whether to lease or own branches or headquarters facilities is that it depends on each credit union's situation, market conditions and opportunity.

Good Deals out There
Today retail and office development property is selling for 20 percent, 30 percent or even 50 percent of the going price just 18 months ago in many markets. We are at, or near, the bottom of the real estate price decline as recent indicators suggest prices are starting to turn upwards. If a credit union is considering building a free-standing branch or a new headquarters, or needing to expand on adjacent land, now is the time to buy or at least control the price and opportunity through a low-cost option agreement. It is feasible to purchase land now and hold it for three to five years and even longer without running afoul of regulators. If you change your mind at a later date, the land can likely be sold for a substantial profit.

Another reason to consider purchasing now is the availability of land that was not previously for sale. Great branch sites are often located at or near the entry of a successful mall or adjacent to "big box" stores. Between 2004 and 2009 developers stopped offering these sites for sale, preferring land leases that provided high on-going income and long-term appreciation. The cost of leasing these sites was very high and, in addition, involved the cost of constructing a building, the value of which declines, rather than appreciates, as the ground lease termination date approaches. Today, many of these sites previously unavailable for purchase are available at reasonable prices, making break-even timing much shorter.

In our strategic growth and branch planning work we recommend both purchasing and leasing branch facilities, depending on a number of critical factors. Is the existing or potential market large enough to support the cost of a free-standing branch? How long will it take the target market to grow to a reasonable level of support and profitability? Will this branch break even in 18 to 36 months or will it take longer? Is a free-standing branch needed to project the credit union's commitment to the community as a brand statement? Are we certain about the location long term? Could the target market shift or overall market dynamics change, requiring a future location adjustment? Do we need to deploy a number of leased branches quickly to create high market efficiency and productivity (critical convenience mass), or will one free-standing branch suffice?

Have a Branching Plan
Most credit unions own their headquarters facilities while most banks lease. The simple reason for the majority of both choices is tax status. But there are other variables as well. A credit union may wish to use its resources to build a strong branch network, leasing operations space for five to seven years and then building or purchasing a building for long-term occupancy.

Today, credit unions should simultaneously complete both a strategic branching and headquarters occupancy plan. This will enable the credit union to understand the resources necessary to accomplish its growth and profitability goals as it considers whether to retain the existing headquarters and lease additional space for the short term, expand, purchase an existing building, or build a new facility. This methodology analysis has changed the thinking of many management teams and boards, and established a solid resource base upon which to build both growth and occupancy strategies.

Credit union CEOs must wear two hats when guiding branch and headquarters occupancy: that of both a CEO and a real estate developer. This creates a balance of objectives, which provides the greatest benefit for the credit union over time. A few of the important real estate questions in branching are: Should we build a 3,200-square-foot branch on our one-acre site, or should we develop the site to its best use and construct an 8,500-square-foot facility that will provide for expansion and generate income and a high future sale price? Should we lease a branch of our design from a developer and then purchase back at a later date so that we have funds available to take advantage of low land and construction costs and add more branches more quickly?

There are similar questions to ask when considering a headquarters purchase or new construction. Should we lease and purchase in the future or own outright? Should we build for our needs only, or would it be more advantageous to build a large building that we can lease out and occupy over time? Should we pursue a development partner? Are commercial condominiums in a mid- or high-rise a good idea? Is there an advantage to working with a design/build firm that can hold an equity position in the project to allow financial flexibility?

The same questions arise when a merger is being considered. Does the potential merged credit union pursue the same real estate strategies? What will it take to align the properties with our strategy? How do leases vs. ownership impact future delivery flexibility and market efficiency of the joint branch network?

Answering the question of whether to own or lease headquarters or branch facilities must be in support of the credit union's business and growth strategies. The answer could be as drastic as selling all facilities and leasing back to generate needed capital, or as simple as making no change at all. Our advice is to be certain that both your branching and headquarters occupancy strategies and tactics align with your business objectives. With these strategies in place, you can then move forward with initiatives like branch network optimization, market expansion, mergers, and creating a strong branded member and staff experience within the most productive facilities for many years to come.

Paul Seibert, CMC, is VP/financial services at CUES Supplier member EHS Design, Seattle, and the author of CUES Complete Guide to Credit Union Facilities.

• Go to the current issue of Credit Union Management magazine.