Guide to outsourcing

David Lawson - 2002


The jury is still out on the merits of  outsourcing property services. It doesn’t help the debate when confusion reigns over terminology, particularly when there are differences – some subtle, some serious – which can have a significant impact on the managers caught up in this revolution.

Private Finance Initiative  was launched to harness private capital for public sector services and now covers around £20bn of  property, transport, health, education  and community developments.

  The groundbreaking project was PRIME, involving transfer of 700 DSS properties to Trillium, now part of Land Securities, the UK’s largest property company. It broke the mould of a simple landlord-tenant relationships, centring around a 20-year flexible, serviced contract, including facilities management.  Next came STEPS, under which  Mapeley took over 600 Inland Revenue and Customs & Excise properties.  The Home Office, Treasury, and Ministry of Defence are also exploring PFI schemes for central London.

  The IR deal has been rediscovered by the media, which is fulminating about the irony that  ownership is held in an off-shore tax shelter. Advisors respond that the National Audit Office has estimated that PRIME will save the government around £560m. But this is not merely a way of raising cash by selling buildings. Government bodies face a huge rationalisation and modernisation programme to cope with IT and new working techniques. PFI aims to tap private sector property expertise,  transfer  development risks but share the benefits of disposals and rationalisation through profit-sharing arrangements.

 It also provides   greater  operational flexibility, rather than being tied into long leaseholds, while  combined contracts mean accommodation and service costs are fixed for 20 years or more.

Corporate Outsourcing emerged as the private sector saw a lesson in government  reform. Under pressure during the recession to cut costs, outsourcing of services had become commonplace. The next logical step was to spin off non-core activities such as property. This pressure was  maintained during the economic revival as companies come under pressure to enhance shareholder value. The recent stock market slump has added further motivation.

 The process has also been sent into overdrive by proposals for changes in accounting rules. Within the next few years these will demand that property costs are included in balance sheets. Outsourcing of services such as facilities management in the nineties has also been a factor, taking occupiers past the difficult threshold of letting outsiders into company ‘homes’.

  Sale-and-leaseback has long been the most common way to spin off property. A firm will sell the freehold to an investor/landlord but remain in occupation by taking a lease. The lump sum can boost a sickly balance sheet but may be an expensive way of raising capital, particularly when interest rates are low. It also commits the  seller to paying rent over a relatively long period. It rarely impacts day-to-day services as  leases traditionally insist on the tenant taking responsibility for insurance and repairs. Only when several tenants share premises will the landlord become involved in common parts such as stairs, reception areas and grounds.

  Securitisation is a sophisticated financial variation on this theme., where the occupier effectively sells its property in exchange for bonds, secured on the future rent flows. Sainsbury recently did this on 16 stores.

 Corporate PFI goes beyond this traditional format.  Abbey National, for instance, sold all its 1,300 properties to Mapeley for £465m but the point of the exercise was not primarily to raise cash. It needed a more flexible format to cope with an uncertain future as the financial services sector changes. A  ‘structured’ sale-and-leaseback was set up which fixed future costs but allowed a variety of lease lengths and flexibility in changing leasing conditions. The deal also included property management but not facilities management, which was hived off as part of a separate joint venture.

   British Telecom also went out side the envelope in its deal with Telereal (a Land Securities Trillium/William Pears joint venture),  which involved a sale-and-leaseback of over 6,000 properties in return for £2.4bn. The new landlord is effectively providing serviced accommodation. BT also has the flexibility to vacate a proportion of the portfolio each year under the 30-year deal, and shares any development or disposal gains.

  The BBC opted for a more comprehensive 30-year deal with LS Trillium which includes both estate and facilities management on its 4m sq ft portfolio. The broadcaster will pay £35m a  year for these services rising to double that when a new base is completed at White City in London. LST will invest £220m to develop the centre. The contract has flexibility for extension to the rest of the estate and adding extra services.   Consultant Alan White at DTZ Pieda believes the move to Corporate PFI will be limited, as companies will be reluctant to give up control of their property.

  Real Estate Partnerships has evolved as a generic term for all these variations, whether between public and private sector or tenant and landlord. But not all justify the label. Many sale-and-leasebacks are little different to an occupier going out and renting accommodation, then getting on with handling – or outsourcing - the wide range of property services landlords traditionally ignore.  And occupiers are increasingly disillusioned with inflexible long leases.

   Even deals which include property and/or facilities management can fall short of true partnerships. Corenet, the umbrella body for corporate real estate executives and consultants, believes  a more equal  relationship will replace the supplier-customer model, with both sides deciding on  strategic policies.