Archive for the ‘Capital Markets’ Category
« Older Entries |5 things every corporation should do to prepare for the upcoming lease accounting changes
Wednesday, January 25th, 2012
By Brant Bryan, Principal
In the near future the FASB and the IASB will jointly issue new guidelines for lease accounting. These new standards are substantially different from the current standards and will affect every corporation that issues public financial statements.
In the new standards all leases will be reflected as both an asset and a liability, thus “inflating” the size of corporate balance sheets. During the lease term, the asset and the liability will be expensed, but in different patterns than under current standards.
The new standards will likely become effective in about 2 years. What should corporations be doing now to prepare for this sea-change of lease accounting?
1) Update your lease database. The new accounting standards will require corporations to assign a value to every lease transaction. The value will be based on more information than most corporations now include in their lease database.
2) When entering into new leases evaluate them using both the current lease accounting implications and the new standards. All leases will be included in the new standards. There will be no “grandfathering”. Therefore, you need to know what impact each lease will have on your financial statements in both 2012 and in future years.
3) Examine the effect of lease length on your financial statements. Longer term leases will normally cause a greater increase in the size of the lease asset and liability. How will increased balance sheet size impact your performance ratios and metrics? Begin to establish a philosophy of what your company wants.
4) Talk with bankers, real estate consultants and rating agencies about how the changes will impact your credit capacity, rating and borrowing cost. Leased assets will be a separate category on the balance sheet and effectively is a source of financing for lessees. Most companies believe it should be “business as usual”, but understand what it means for you and your borrowing costs.
5) Look again at the options in your leases and how you structure those options. More than ever, lease options will be important. Some rent streams may shift onto or off of your balance sheet, depending on your objectives and the facts and circumstances. Also, the new standards may cause you to prefer your options to be structured differently than you have done so previously.
Tags: corporate real estate, FASB, IASB, lease accounting, lease structuring
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Valuations Still Uneven, Vary by Product Type
Wednesday, July 27th, 2011
By Jim Leslie, Principal
Valuations of commercial real estate product continue to vary by product type. Primarily due to the housing crash and the continued fallout of the mortgage debacle, most multifamily rental communities are showing signs of stability as well as rent increases. The industry is welcoming back individuals who had become home owners with the relaxed mortgage underwriting but now find themselves renting again. The experiment of making everyone a homeowner has shown to be unsustainable, recharging demand for apartments. Investors are rushing to purchase this product type at very competitive cap rates as they feel rent will continue to increase in the foreseeable future.
Office product has not been embraced by these same capital sources, and it is still difficult to find money (debt or equity) to fund new construction. Other than 100% fully leased build-to-suit opportunities, very little new construction is occurring in most areas of the country. In addition, landlords are still working to modify their capital stack to reduce leverage and extend terms. As a result, many landlords are finding liquidity to be a challenge and that is creating problems for them in negotiating renewals as well as limiting their ability to close new leases. Tenants should be looking at their current portfolio of leased properties to identify those landlords with liquidity issues and approach the landlord now to probe options which will be beneficial to the tenant and may also be helpful to the landlord. For example, a recent transaction allowed for the tenant to pay for tenant improvements in exchange for a reduction in rent, giving the tenant a 15% annual return on the capital it invested in the improvements. That is a 10 year investment return of 15% compared to a 10 year treasury rate of 3%. How many Chief Financial Officers would love to get a 15% return on their own operations and not worry about the investment? These kinds of returns are more the norm than the exception and can have a meaningful impact on the stated rent in the lease agreement. It also allows the tenant to effectively gain long-term occupancy at below market rates regardless of who eventually owns the building. Other opportunities exist for tenants to purchase the buildings they occupy at below replacement cost values. They will eventually be able to take the building back to market in a sale leaseback transaction utilizing the credit of their balance sheet to maximize value. We are seeing some developers beginning to sell some of their owned portfolio to free up liquidity for their remaining assets. They recognize this is not a strategy that maximizes value, but they are going through a unique time and are looking to keep what they can. It seems all of them are repeating the mantra: “it is what it is.” This is an ideal time for a tenant to approach their landlord to see if a transaction can be accomplished. There is no harm in pursuing those assets which you feel are quality and strategic to your core business.
This opportunity will exist throughout 2011 but it is beginning to appear that all “troubled” real estate investment portfolios will be either recapitalized or sold by 2012, creating a much more stable and patient landlord for the future. Now is the time for tenants to aggressively review their own portfolio to see if opportunities exist within their markets.
Tags: corporate real estate, landlord, tenant, valuations
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Accounting Boards Come Full Circle
Wednesday, June 1st, 2011
By Brant Bryan, Principal
If you are into accounting, this is high drama.
After lengthy debate, the US and International Accounting Boards (the FASB and IASB) tentatively decided in their May meeting to have all leases accounted for as a financing lease. This reversed their decision earlier this Spring which would have provided an additional classification allowing some leases to be accounted for on a straight line basis. The Board decided that it is less complex, overall, for all leases to be accounted for through a single approach.
What does this mean for tenants? ON A TENTATIVE BASIS, here are some highlights:
-All lessees will reflect a front-loaded pattern of expenses. Expense will be a combination of interest expense and an amortization of the recorded asset. Higher interest expense will be charged during the early periods of a lease.
-All leases will be capitalized and added to the balance sheet as an asset and a liability.
-All measurements will be made as of the lease commencement date.
-At the beginning of a lease, tenants will determine if they have significant economic incentive to exercise options for renewal, expansion, purchase, etc. If there is such incentive, the options shall be included in the measurement of lease asset and liability.
-Reassessment of lease options will only be required when there is a significant change in economic incentive. Market based factors will not be considered in reassessments.
-The discount rate used in determined lease liability or asset value will only be revised when there is a reassessment caused by a change in economic incentive to exercise options.
-The Boards did not reach a consensus on whether there will be one or two models for lessor accounting, and thus that is still an open item.
-The Boards expect to complete the lease project by the end of 2011. Implementation will likely begin in 2013 or 2014.
As the Boards reach more decisions and release more information, we will let you know what is being said and what this might mean for tenants.
Tags: corporate real estate, FASB, lease, tenant
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Changes in Lease Accounting Simplified
Wednesday, March 16th, 2011
By Brant Bryan, Principal
The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) tentatively agreed to revise some of the proposed lease accounting standards. Nearly 800 letters and comments had been sent to the Boards in response to the proposed changes, and as a result, the Boards are simplifying portions of the new lease standards. However, the Boards remain firmly committed to requiring that all leases be recognized on the balance sheet.
What Has Changed?
The tentative changes from the initial Exposure Draft that will have the biggest impact to corporate tenants are:
-Defining Lease Term as the base term plus only option periods for which there is significant economic incentive to extend.
-Leases with variable lease payments (such as percentage or contingent rent) will have a threshold for inclusion in lessee’s lease liability and asset.
-Creating two classifications of leases: (1) Finance Leases and (2) Other-Than-Finance Leases.
-Affirming the direction of the Exposure Draft to require all leases to be reflected on the balance sheet as both an asset and a liability.
What Are the Specifics of the Changes?
In a significant change from the Exposure Draft, the Boards decided that all lease terms will be the contractual minimum period plus any optional renewal periods for which an exercise of the renewal option is reasonably certain. Reasonable certainty will be based solely on economic factors within the lease, such as bargain pricing on renewals. The Board plans to provide specific criteria to be used in this assessment. These tests likely will be very similar to the current GAAP standard concerning renewals. The ED had proposed including renewal terms if they were more-likely-than-not to occur based on a wide variety of factors, including lessee past practice, market conditions, and lessee intent.
One change that will greatly simplify life for corporate lessees is that there will be fewer reassessments of renewal options during the lease term than the Exposure Draft had proposed. Reassessments will only need to occur when economic factors affecting the decision to extend or terminate a lease change significantly. Lessees will not need to search for reassessment events.
The Boards also decided that variable lease payments tied to an index or rate would be included in lease calculations using the current rate, or spot market, for that index or rate, rather than a forward projection. There will also be thresholds for including contingent rents in leases (such as percentage of sales). Such contingent payments will only be included when they are virtually certain. If variable payments are, in substance, minimum lease payments, they shall be included based on such minimum.
There were also discussions regarding several other issues, including: which agreements shall be defined as a Lease, Residual Value Guarantees, and Lessor Accounting.
Two Types of Leases:
In another significant change from the Exposure Draft, the Boards tentatively decided there will be two classifications for leases, and each type will have a different pattern of recognition in an income statement. All leases will either be a (1) Finance lease or (2) Other-Than-Finance Lease. The Boards will develop criteria for distinguishing between these two types of leases.
A finance lease will be viewed as a financing transaction. The pattern of income for a finance lease will be consistent with the methodology presented in the Exposure Draft as it will be treated as a financing, with more expense early in the lease term. If the lease is similar to a rental transaction and financing is not considered to be a significant part of the transaction, the lease will be treated as an Other-Than-Finance Lease. The pattern of income for an Other-Than-Finance Lease will be consistent with current US GAAP (straight lined or leveled).
What Is Next?
Deliberations will continue, and other changes may be forthcoming before a final lease accounting standard is issued. June 30, 2011 is still the target date for finalizing the new standards. The exact schedule for formal adoption of the new standards has not been set; however, most observers expect larger corporations to begin reporting under the new standards with their 2012 fiscal year-end.
Tags: corporate real estate, Exposure Draft, FASB, IASB, lease, lease accounting
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The Window for Access to Low-Cost Capital is Now
Wednesday, January 19th, 2011
By Jim Leslie, Principal
After two long years of limited liquidity available for real estate, things are just now beginning to thaw. Interest rates continue at unprecedented lows and will continue at these levels for some time into 2011, making this the longest cycle we’ve ever had with interest rates being this low. Now, with businesses getting their feet back under them and some modest growth projected for the economy, companies should be giving thought to monetizing their real estate assets. In the near future, the lease accounting rules will be changed, causing all owned and leased real estate to be shown on the balance sheet in some form. This change turns nearly every real estate decision into a financing transaction, and corporations should be taking advantage of these opportunities to lock in long-term, low interest rates.
A recent lease for a credit tenant came in at 300 basis points over the 10-Year Treasury. This non-investment grade corporation effectively received 20-year financing at less than 6%! Lease alternatives in the market would have priced the corporation’s occupancy cost at over 50% higher. As you can see from this example, the capital market is now available for most corporations to properly monetize their real estate assets at unprecedented, low-cost yields.
So where should companies be looking to take advantage of these opportunities? Three main places come to mind. First, they should start with any real estate they currently own on their balance sheet. Secondly, they should look at any current leases of significant amounts of space that occupy the majority of a building. Finally, if the company is currently looking for space in a market with numerous opportunities in the form of empty buildings, they should consider requesting both a purchase proposal and a lease proposal. This would allow them to perhaps find a cheaper source of capital, resulting in significantly lower occupancy costs.
2011 will be an exciting time for those CFOs and treasurers who have some foresight to take advantage of these low interest rates. In a business environment where costs are part of the competitive advantage, you don’t want to miss this window—we may not see it again for tens of years.
Tags: corporate real estate, credit, interest rate, lease accounting, liquidity, tenant
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Future Real Estate Transactions May Impact Lease Economics
Wednesday, September 15th, 2010
By Jim Leslie
As the Financial Accounting Standards Board (FASB) changes in lease accounting rules continues to gain momentum for adoption within the next few years, corporations should now begin setting strategy for future occupancy expenses. These new rules requiring all lease obligations to be capitalized and shown on the balance sheet of the tenant (eliminating FAS 13 calculations for determining operating lease treatment) may change the attitude companies have towards owning versus leasing. The critical component will become the underlying cost of capital for the landlord/owner as compared to the cost of capital for the tenant. This may require developers and landlords to become more sophisticated in the underlying financing to provide capital to their buildings. While this change may seem overwhelming to many, it is similar to the international accounting rules that have been in effect for years. American CFOs may want to look to their colleagues in those markets to get some baseline knowledge on how deals are structured and gain some initial thoughts on efficient structures for their own balance sheets and operations.
In addition, the proposed accounting rules will have an impact on loan covenants currently in place, which will need to be renegotiated or waived. Traditional calculations for valuations of companies will change as the reporting of occupancy costs may cause a different result for EBITDA or Free Cash Flow. Many of these defined terms in loan agreements will trigger a default under the new rules.
While some corporate real estate professionals have begun thinking about the impact this will have on their future transactions, it does not appear many landlords have given it much attention. Change brings a lot of confusion and uncertainty, but it will also create some new opportunities that were not available under the old accounting rules. Now is the time to be forward thinking and lead your company into the new era. The professionals that can thoughtfully consider the ramifications of the new accounting rules and the impact it will have on the financing market will certainly be highly regarded by their peers and supervisors.
Have you been thinking about the proposed FASB changes and how they will impact your business?
Tags: corporate real estate, EBITDA, FASB, Free Cash Flow, lease accounting
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A Guide to Addressing Commercial Loan Defaults: Part II
Friday, July 23rd, 2010
By Craig Zodikoff and Tyler Kellogg
In Part One of this entry, we presented the topic of landlord financial difficulties and how tenants can leverage their rights. We introduced three scenarios, starting with tenants who are completing a lease within three years. Now, in Part Two, we address other circumstances that may be appropriate:
Scenario # 2: Tenants in Buildings at Risk for Default, Delinquency, and Landlord Liquidity Issues
Tenants in at risk buildings need to know specific details in their lease agreement. Your lease may have been negotiated with certain protections against this type of event. Even so, every lease is different, and not all of them offer adequate protection. Tenants should learn and understand the default process and the roles of each party. Tenants should also record a “Request for Notice of Default” so that they will receive notice of the initiation of any foreclosure proceedings against the landlord.
To protect your interests, take the following measures:
-Review specific details in your lease. Check your right of self-help and rent offset in the event of landlord default in payments for improvement allowances. Also, pay special attention to your non-disturbance clause.
-Identify concessions or benefits that haven’t been realized or might be challenged by a new landlord. Do you have unfunded tenant improvements, fixed-rate renewal options, or back-loaded free rent during or at the end of your lease term?
-Evaluate your building. Are capital improvements needed? How responsive is building management?
-Learn and understand the foreclosure process. What are the steps in a foreclosure process? Who are the people involved in a foreclosure process? What are their roles?
-Seek advice to clear up any issues.
Scenario # 3: Tenants Who Think Their Building Is Not at Risk
A lesson from this recession is to not assume companies or institutions are safe. Your current landlord might appear to be in a safe position, but it is prudent to investigate potential risk. Although the investment markets are still slow, your building may sell to a new landlord. Given the risk, it is appropriate to do a thorough review and evaluation of your lease portfolio. If you are planning to renew at your current location, you can improve upon the non-economic terms in your lease.
How do you know if you’re in an at-risk building? Determine when the building was acquired, at what cost, and what type of debt is on the building. Be cautious if your building was acquired and financed in the past few years. Next, look at what type of owner and what type of lender are involved in your building. This information might give some clues to the likelihood of certain outcomes in the event of debt or liquidity issues.
What does the reality of commercial loan defaults mean to the leasing market? The obvious impact is a continuing trend of declining property values. Many properties will be acquired by new owners at a lower cost. The new landlords will be able to offer more competitive lease transactions than landlords who acquired a building at a higher basis. This will help sustain today’s competitive leasing environment and provide significant concessions for tenants.
This is good news for companies, especially if they partner with the right advisors and legal counselor to protect their rights.
Tags: commercial loan, default, landlord
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A Guide to Addressing Commercial Loan Defaults: Part I
Wednesday, July 21st, 2010
By Craig Zodikoff and Tyler Kellogg
While the financing of commercial real estate has received much attention this past year, most of the focus has been on the impact on banks and property owners. But what about the implications for tenants? Do they have an opportunity to leverage their negotiating strength as landlords continue to struggle?
The contributing factors that led to the Corporate Real Estate (CRE) credit crisis are obvious. CRE investment markets exploded with record years leading up to the recession. During this period, property values climbed, and lending practices loosened.
As the recession deepened, landlords were forced to lower rental rates and increase concessions. Today’s rents cannot accommodate many of the debt structures placed on buildings over the past few years. Many CRE loans are at risk of delinquency, and many are set to expire in the next couple of years. Normally, these loans would simply be refinanced. However, while credit markets have improved, many experts are wondering how these buildings can secure new loans given the current loan-servicing abilities of the properties and the availability of loans.
This issue is also critical to tenants and end users. There are specific steps companies can take if they are in the middle of their lease: evaluate upcoming lease expirations or negotiate lease agreements. Companies should look at ways to minimize their risk in existing leases and in new lease transactions over the coming years.
First, consider which of the following three scenarios best matches your situation:
-Tenants Completing a Lease in the Next Three Years
-Tenants in Buildings at Risk for Default, Delinquency, and Landlord Liquidity Issues
-Tenants Who Think Their Building Is Not at Risk
In this blog entry, we will look at the first of these scenarios. In the next entry, we will focus on other circumstances that may match your situation.
Scenario No. 1: Tenants Completing a Lease in the Next Three Years
Today is a great time to evaluate your lease portfolio and negotiate lease transactions since there has been only modest absorption of vacant space, even as the economy slowly improves. While tenants remain cautious and sensitive to increasing operating costs, they should recognize that the CRE lending crisis has put an unusual twist on the leasing market: In the past, landlords thoroughly vetted their tenants to analyze the risk involved in lease transactions. Tenant risk is still a factor, but tenants now need to do more investigation of their landlord to evaluate landlord risk.
You should evaluate your current and potential landlord in terms of the following:
-Who are they? What type of landlord/ownership?
-When did they acquire the building?
-What type of debt is on the building? Who is the lender? What type of lender? What is their role in transaction approval?
-What capital improvements have been made? When were they made? How were they financed?
-What are the building operating expenses? What is the likelihood of the landlord cutting back on expenses?
-When was the last tax assessment of the building? Has the property value declined since the acquisition? Is the landlord challenging the most recent tax assessment?
-What is the current vacancy and projected rollover in the building? How does the landlord vacancy and churn look over the coming years?
-Has the landlord completed any lease transactions recently? Is the landlord negotiating with anyone else right now?
Negotiate the lease terms to reflect the risks of the current market:
-What is your right of self-help and offset of rent in the event of landlord default of payment of tenant improvement allowances and failure to maintain the building? What specific terms are included?
-What is in your non-disturbance clause? How protected are you?
Stay tuned for Part Two of our blog entry on Friday.
Tags: commercial loan, default, landlord
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Underlying Basis for Commercial Properties is Changing
Wednesday, June 23rd, 2010
By Jim Leslie
Commercial properties are beginning to show some sales activity, which creates opportunities for tenants in negotiating leases if they do some basic due diligence. It takes more than a thorough understanding of market rents in your market to find the lowest occupancy cost which can be achieved. While there was a period of time when market knowledge was the primary factor in negotiating the rental rate, we are moving into a new era where you need to know if the building ownership has changed, who the new owner is, and how much invested capital they have in the building. In many instances this change of ownership has not yet occurred, but the landlord may be delinquent in his obligations to the mortgage holder and it is simply a matter of time before he will be either transferring ownership to a new investor or to the mortgage holder. As a result, it is important to know the status of the maturity of leases in the building as well as the underlying debt terms in order to reasonably forecast the future financial health of the landlord.
We are seeing buildings trade at discounts to replacement costs and in some instances at values below the current debt levels encumbering the property. The new owner may have the ability to quote and execute lease rates below the current market value and still achieve attractive economic returns to their invested equity. For example, we recently saw an office building that required a NNN rental rate of $22/SF in order for the owner to achieve an unlevered yield on a cost of 8%. The current lien holder foreclosed on the collateral and sold it to a new investor at a discount to the face amount of the debt. Market rents for this product were NNN $16-$18/SF at the time of the transfer to the new owner. Fortunately, the reconstituted basis allowed the new owner to quote NNN $14.40/SF and achieve a 9% yield on unlevered cost. Being aware of the sale transaction as well as the market rents gave the tenant extra leverage in its negotiations with the landlord.
All tenants should expect and demand this due diligence from their Advisor so that they have the ability to use the knowledge in negotiations with landlords. You will be disappointed if you go forward with a transaction you feel is market-driven, only to find out later that the building ownership had transferred and the new owner was in a position to negotiate a lower deal, simply because their basis was lower. This phenomenon will exist for roughly two years, and it is important for all tenants to recognize it and adapt their process in acquiring new space or renegotiating current lease obligations accordingly.
Are you seeing this sales activity in your market?
Tags: building ownership, debt terms, market rents, rental rate, sale transaction
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Acquisition Opportunities are Beginning to Reveal Themselves
Wednesday, March 31st, 2010
By Jim Leslie
There has been a lot of speculation over the pending doom of real estate values and the resulting opportunities this will bring for steep discounts in selling prices. To date, there have been very few transactions completed particularly at rock bottom prices. Buyers are now starting to adjust their expectations and we are beginning to see more serious discussions with sellers. Banks have been reluctant to take significant discounts until their capital ratios have shown some recovery. This is now happening after a year of very low interest costs has allowed the banks to record strong earnings. The CMBS special servicers have either extended maturities or negotiated forbearance agreements to support the borrower through the depressed market.
The only assets selling at big discounts to par are class C buildings with little hope for the future. As a tenant, it is important to monitor these transactions or extensions as it will impact how buildings are operated and marketed. Very few lenders are declaring a maturity default if the borrower is current and well regarded. They are opting to extend the loan until the financial markets recover and the borrower can either refinance or sell the property. But if the building is not producing sufficient cash flow to service the debt with limited future prospects, they are willing to foreclose and pursue alternative exits. This can create numerous opportunities for the current tenant or a prospective tenant. Depending on the credit worthiness of the tenant there are numerous financing transactions that can be utilized to minimize occupancy cost and perhaps participate in some long-term appreciation. Lenders look at deals differently if it is an owner-occupied facility. For banks, this is categorized as something other than a real estate loan. They have pressure to make new loans but are restricted on doing traditional real estate lending. An owner-occupied facility will bring a lot of interest and proposals.
Your real estate professional should be knowledgeable of these debt situations and be able to anticipate the most probable course of action for each lender. There is not one solution as we have found that the execution varies widely from lender to lender. Lease rates can vary materially if you properly analyze and understand these issues. We have seen tenants reduce their annual occupancy costs by as much as 40% working through the analysis and strategically approaching the lender or landlord depending on the situation. The financing environment has changed for the time being and anything short of a thorough evaluation of these markets can be very costly to the tenant.
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