What falling oil prices mean for real estate

With oil prices falling, energy sector deals are sure to arise—and real estate will play a key role. Here’s how.

The price of crude oil has fallen by more than half since June 2014. And as oil prices drop, merger and acquisition (M&A) activity rises. Consolidation amongst oil and gas producers will almost certainly drive a series of high-stakes battles, leaving successful acquirers to navigate a rapidly evolving and increasingly complex real estate landscape.

We sat down with Houston-based Bruce Rutherford, leader of JLL’s Oil & Gas practice group, and with Leila Lance, JLL’s change management and M&A expert, to talk about the role real estate will play in the coming deal boom.

Q: Which energy firms are most likely to be acquired while oil prices are low?

Rutherford: Most experts agree that land-based exploration and production companies and the drilling, engineering and services and equipment companies that service them are the most vulnerable. The weaker their balance sheets the more vulnerable they are to being acquired or forced to sell assets. The S&P SmallCap 600 Energy index, which tracks small energy companies, dropped 47 percent in the last six months, according to The Wall Street Journal. Similarly, Bloomberg reports that restructuring firm Conway Mackenzie expects to see oil drillers and the exploration companies that employ them take a big hit in the second quarter. Acquirers are expected to gobble up attractive reserves and mineral lease acreage, weaker companies with attractive assets, or divisions of companies.

Establishing a process, including a single point of contact to coordinate integration activities across the entire firm is essential to achieving the intended cost savings.
Leila Lance – JLL Change Management and M&A expert

Q: What kind of shake out will this M&A activity have on commercial real estate?

Lance: Shedding duplicative space in office buildings, distribution centers and other types of commercial properties is standard following any deal. Markets most impacted by this M&A uptick will include the usual suspects like Houston, Denver and Calgary.

While these cities have experienced the upsides of a booming energy sector, low oil prices offer a reminder that the party over the last few years will not last forever.

Rutherford: In Houston, energy tenants take up more than half of the city’s top properties in the central business district and more in other submarkets. This has been a strong growth driver in the past couple of years. However, it’s now exposing the market to greater risk.

Houston’s real estate market will feel a sting from low oil prices and industry consolidation:

Q: How do smart energy companies and their financial partners use real estate to make M&A transactions successful?

Lance: During the due diligence process investors will have a close eye on real estate assets well before a transaction closes. Identifying duplicative real estate assets of the combined company early on can help the M&A deal evaluation process go more smoothly.

Aside from eliminating obvious duplication of co-located or repetitive-function locations, companies should examine the footprint of both companies in geographies where the business is slowing because of depressed oil prices. For the more optimistic investors, subleasing space to offset what may be a temporary slowdown keeps more real estate under a company’s control while keeping costs in check.

Supply chain facilities are also a key target for cost savings, as production growth slows under the shadow of low prices. But companies should think carefully before selling off land rights or assets that could be more expensive to buy or lease back when prices return to normal.

Q: What else should they know?

Lance: No merger or acquisition is one-size-fits all, but you start by asking the right real estate questions (see table). Once you’ve vetted a deal’s potential through this lens, the real action begins after the deal closes.

Establishing a process, including a single point of contact to coordinate integration activities across the entire firm is essential to achieving the intended cost savings.

Rutherford: With the right coordination in place, two merged companies can make sure post-acquisition real estate decisions are strategic—and not short-sighted.

Taking the long view can not only get a company through this period of low pricing, but help place them in the right locations for production growth when revenue returns. Like a successful chess move, achieving this strategic positioning will set up the combined firm for industry dominance for years to come.

Acquiring an energy company?

Critical real estate questions to consider before the close:

Are you prepared to capture short term operating savings by systematically assessing facilities operations?

How will the two CRE organizations be combined around a new operating model and with the right capabilities?

In which markets do portfolios overlap?

Where can real estate assets combine?

Are there hidden risks in the portfolio that constrain the ability to realize synergies?

After the close:

What is the best way to integrate real estate teams and processes?

What type of work produces the most value for the combined company?

How do we communicate and manage plans to relocate our employees?