**Controlling Operating Costs With an Effective Real Estate Strategy**

Joseph Rubin and Peter Brooks

The financial services industry is operating in a rapidly changing
economic environment. The demise of the Glass-Steagall Act and the
desire for the benefits of scale have provided a springboard for the
cross-sector mergers of high-profile players like UBS Warburg/Paine
Webber, JP Morgan/Chase Manhattan, and Credit Suisse First Boston/DLJ.

Such industry consolidation, as well asinsurer demutualizations and
globalization initiatives, have given way to rampant cost-cutting
measures as the economy has slowed and revenue growth has stalled. Faced
with an uncertain economic outlook, financial services companies are
once again emphasizing maximization of short-term profitability,
increasing efficiencies, and deriving revenue from existing assets.

Real estate, while often overlooked, can be strategically positioned to
boost long-term financial results, drive organizational change, and
reduce overall operating costs. Here are some techniques financial
institutions can use to align real estate with their long-term business
strategies and achieve cost savings.

Rethink the front-office/back-office split

The pace of financial services mergers and acquisitions has been
frenetic. Whether through large-scale combinations or by the steady
accumulation of niche players in key markets, consolidation among
commercial and investment banks, insurance companies, and asset managers
has increased markedly.

After growing through acquisition for so many years, however, the
industry giants may now have too many nonstrategic employees occupying
expensive space in first-tier markets like New York, Los Angeles, London
and Tokyo. By relocating these nonstrategic functions to less expensive,
second-tier markets, companies can achieve a substantial reduction in
labor and real estate costs.

One multinational insurer with large amounts of leased and owned space
in the high-cost Manhattan market found that it could save a projected
\$60 million over 10 years by relocating several business groups to
lower-cost areas, without any net headcount reductions.

Rationalize back-office function

In addition to having a large amount of front-office space, the largest
financial services companies often have duplicative back-office
functions. During the recent acquisitions spree, almost every company
purchased had its own corporate office, IT support function, and
customer response centers. These functions must now be integrated into
the larger organization to realize the often-touted synergies and
efficiencies related to a merger.

Integration can greatly reduce operating costs by eliminating
redundancies and shifting work from high- to low-cost regions. Often,
integration improves the effectiveness of the

service delivered. An integrated call center network, for example, can
bounce calls and shift loads to meet the varying demand levels of
different businesses.

It's not uncommon for companies to reduce total labor and operating
costs

by 5 to 15 percent by consolidating finance, accounting, payroll, IT
support, and other functions into shared services centers that serve the
entire enterprise. One commercial bank that had been attempting to
maintain three full-service check-processing facilities in a major city
realized annual savings of \$15 million and improved service delivery by
consolidating the three operations into one mega- processing center with
two smaller, regional centers.

Conduct energy and lease audits

Energy and lease audits also can contribute to cost savings. With the
recent spike in energy costs, companies are performing energy audits and
implementing energy upgrades, often with the aid of energy rebates and
subsidies, to manage their energy demand. As the energy markets become
more liberalized, companies have an opportunity to negotiate competitive
commodity contracts and hedge against wild price fluctuations. Also, by
closely comparing lease terms and reviewing operating expenses,
escalations, and passthroughs, companies\
can monitor their real estate costs and, in some instances, renegotiate
terms with landlords\
or vendors.

**Minimize project construction costs**

Although fewer new real estate projects are usually initiated in times
of economic uncertainty, management has little appetite for cost
overruns and delays on those projects already under way. For these
projects, project management oversight and cost segregation can minimize
the costs of new facility construction or interior build-out.

Project management oversight, including close monitoring of contractors,
enables companies to ensure that projects remain on-time and on-budget
and helps to avoid costly construction disputes. Opportunities also
exist to minimize and defer taxes by segregating construction-related
costs into proper categories for federal tax depreciation purposes. This
results in a faster write-off for tax purposes and a significant
cash-flow benefit. Our experience indicates that greater attention to
classifying such costs can generate tax benefits approximating 2 to 4
percent of total capital construction costs.

**Evaluate capital redeployment opportunities**

As analysts continue to pressure financial services companies to
maximize their returns and develop new revenue sources, some companies
may find it financially advantageous to redeploy capital from corporate
real estate and reinvest it in their core business.

Although owning real estate is financially prudent in some situations,
companies that are capital-constrained or cannot otherwise fund mergers
or other strategic initiatives may wish to enter into sale-leaseback
transactions to monetize their real estate assets. While these
strategies may increase the annual cost of occupying the real estate
involved, sale proceeds can then be redeployed elsewhere in the
business.

In addition to sale-leasebacks, companies are now scrutinizing their
portfolios for opportunities to raise cash by disposing of nonstrategic
assets. Often, these unwanted real estate assets creep onto the balance
sheet as part of an acquisition and can raise needed cash without
affecting principal businesses.

Explore economic incentives

Economic incentives can often play a decisive role in determining where
to expand, contract, or grow new businesses. While incentives should
never displace the pure business fundamentals of markets, costs,
suppliers, and labor as determining factors when selecting locations,
they can be used to select between two or more equally qualified
markets.

Incentives are available to help offset the costs of recruiting and
training a new workforce, large-scale capital expenses, and facility
related costs. Whether in the form of as-of-right incentives,
abatements, or negotiated grants, these monies can even, in certain
circumstances, be used to defray the costs of expansion in an existing
location.

Develop flexible strategies

Although real estate is a static asset, financial services companies
must develop real estate strategies that are flexible enough to
accommodate business change. The scramble to find real estate for
rapidly expanding businesses can suddenly be replaced with the need to
quickly dispose of surplus space as firms slash headcount in an attempt
to cut costs.

Real estate departments must be closely integrated into the
business-planning process to anticipate future space requirements and
growth and plan for surplus space disposals. Department managers must
also be aware of organizational restructurings and any changes in the
amount, type and location of real estate the business requires.

When real estate becomes a key strategy instead of a tactical
afterthought, it can have a profound impact on an organization. Indeed,
the most successful results are achieved when companies incorporate real
estate into the business-planning process and use it to achieve larger
strategic goals. Real estate is then transformed into a catalyst that
helps organizations integrate their businesses, increase operating
efficiencies and reduce total costs.

FMJ

About the authors:\
\
Peter Brooks has more than 25 years experience in the real estate
industry, including consulting, brokerage, corporate real estate
management, finance and appraisal. Prior to joining Ernst & Young, he
held positions as a regional direcor of a brokerage firm specializing in
tenant representation, as partner in a real estate consulting and
appraisal firm in New York, as head of Chemical Bank's Corporate
Services division, as a commercial real estate broker and as a college
teacher. He is a member of the Real Estate Board of New York and
chairman of its research committee.

Joseph Rubin is the director of Real Estate eBusiness Solutions for
Ernst &Young's e-commerce advisory practice. he has been a management
consultant focusing on real estate and related financial services for 17
years. He has extensive experience in commercial mortgage finance,
specializing in credit analysis and in structuring mortgage-backed
securities and whole loan sales for institutional and goverment clients.
He is the chairman of the MISMO Commercial Project, a joint effor by the
Commercial Mortgage Securities Association and the Mortgage Bankers
Association to develop industry standards for the commercial mortgage
lending.