By Richard Pilla and Mike Purchia
The Problem
Banks frequently overpay by 20% or more for their branches compared to other end-users of retail real estate for comparable space. Over 10 or 20 years we’re talking a lot of money.
Overhead expense affects the bottom line. A smart business operator needs to increase revenues, but equally important is managing and reducing expenses, particularly in today’s low interest rate environment.
Landlords and developers have the mindset that they can charge banks more than other tenants. Why? Because they have been doing it for years and everyone has come to expect it. Reinforcing this mindset, financial institutions have put up very little, if any resistance, primarily because they are not aware of what other retailers pay or market comps.
It makes no sense. Banks are a clean use. They do not generate trash or attract a nuisance clientele. Unlike restaurants and health clubs, banks do not take up many parking spaces and the turnover is faster, which means more parking spaces for customers of other tenants in a center. Banks are also not open in the evenings, weekends or holidays when most retailers have higher customer traffic. And, their credit is good, not to mention that they typically do not ask for TI (tenant-improvement) dollars as many regional and national retailers/restaurants do.
U.S. banks are carrying in excess of $120 billion in owned corporate properties on their books. Landlords carry an equal amount on their books from bank leases. A five-hundred million dollar community bank is likely to own and lease $10 or $15 million of corporate real estate. By overpaying, you could be looking at $250,000 in reduced annual profits.
Top Bank Real Estate Mistakes
- Pressured by Client Developers – Do I have a property for you! Sound familiar? The inability of bank management to utilize objective criteria in evaluating properties that are proposed by commercial clients starts many banks down a narrow path and backs management into a corner, while risking the loss of a good customer.
- Unnecessarily Disclosing the Bank’s Identity – In most situations there is no need to let the market know that a bank is shopping for a property. You want to establish the terms of a transaction before letting the owner know that a bank is the buyer or tenant.
- Impromptu Deal Negotiations – Real estate developers make their living understanding real estate transactions and being shrewd negotiators. Bankers know banking but often not retail real estate. It’s not a fair fight!
- Not Treating Network Properties as a Portfolio – Branch trade areas frequently deteriorate over a 10-15 year period. Banks need to be flexible and not think that they are locked into a property or trade area. Given the cost of opening a new branch, a poorly performing branch can be a huge negative impact to your bottom line.
- Last Minute Lease Renewal Planning – Most leases have a 6 or 12 month lease renewal notice requirement. Failure to anticipate lease renewals and plan sufficiently in advance reduces a financial institution’s options since the lead time to open a new branch is more than 12 months. Two years before any lease maturity the bank should complete a comprehensive branch performance and trade area analysis in order to guide their renewal/ relocation decision. Why a trade-area analysis? Simple. Shifts in market dynamics, infrastructure deterioration, daytime population changes and competition have a direct impact on a branch’s loan and deposit performance.
- Poor Site Selection – Retail branch properties should have comparable characteristics of the strongest retailers such as McDonalds, Starbucks or CVS. The same property factors that are critical to those retailers, e.g., visibility, ingress, access, parking and synergy need to be present in bank properties.
- Insufficient Research – Key to opening a successful branch is having a sound strategy. Understanding what will drive the success of a branch is critical. Is it commercial or retail-oriented? What are the target demographics? Where are the daily consumer needs met in the trade area? What are consumers’ travel patterns? Understanding the business drivers will help to narrow the geographic search.
- Inconsistent Financial Pro-Formas - Restaurants and other retailers know what they can pay for rent as a percentage of sales. Restaurants and retailers do sales projections for a particular site and then back into what they can pay for rent. Also, pro-forma rent should not exceed what comparable space leases/sells for. Using a financial pro forma which factors in real estate and facility costs as a percentage of a branch’s projected net interest income will take the emotion out of a “go vs. no go” branch decision.
- Not Getting Professional Advice – Most financial institutions are comfortable bringing in investment bankers, outside legal counsel and professional auditors for specialized financial transactions. However, for some reason, many bankers believe that they are qualified to handle commercial real estate transactions. Wrong! This approach drives up costs, reduces profitability, and extends the time it takes to open a branch, and that assumes that the bank has not been aced-out of a deal by another tenant. A real estate professional will also look at off-market opportunities if it is the best real estate in the trade area or community. Do bankers really have the time to do that?
Solutions
Once the decision has been made to open or re-locate a branch in a community, steps that your bank should take include:
Trade area assessment: Learn as much as you can about the community.
- Confer with the community’s planning department to determine the potential impact of any proposed or planned developments and/or transit initiatives on trade area dynamics.
- Identify the retail nodes (activity hubs) within each trade area or community. Rank each node based on the bank’s demographic and business criteria.
Competition: Profile the competition including positives and negatives about their facilities. Today’s consumers are very much driven by convenience. Is your existing or proposed bank branch more or less-convenient than that of the competition?
Real Estate: While you might have your site preferences, you should understand what other retailers have paid and the current prices and terms of other properties that are in the market.
Customer Migration: Where are the bank’s customers really going to come from and what is driving them to your bank branch besides your staff’s wonderful personality? Accurately delineating a trade area is critical in determining superior location.
Site Assessment: How good is a location? Utilize a location rating system that would systematically compare one location to another in terms of visibility, traffic, ingress and egress, parking, branding opportunities, etc.
Design and Facility Considerations: There are many exciting innovations in small branch design. Doing more in less space should be your mantra to drive down capital outlays.
Timeline: Getting sign-offs from abutters, community groups and town planning departments can turn a twelve-month process into a twenty-four month ordeal. Understanding these potential complications may influence your decision to actively pursue a location.
