Corporate Real Estate: Assets & Liabilities-A Guest Post from Llenrock Group
Mar 26, 2014
This post from Eric Hawthorn is part of our Llenrock Group guest post series and originally appeared on the Llenrock Group blog.
Corporations own real estate. Corporations lease real estate. Regardless of the particular sector in which it operates–retail, pharmaceuticals, technology, finance, and so on–a company’s value and performance is greatly tied to its real estate holdings, the value of its leases, and the efficiency with which the company operates its properties.Corporate real estate is an extremely broad topic, so this conversation can go in many directions, but right now I want to look specifically at companies that lease properties. For these organizations, real estate is every bit as much a liability as it is an asset.
Since 2005 or so, there has been a lot of talk about the FASB and IASB’s attempts to revise lease-accounting standards for corporations that rent land, real estate, and equipment. GlobeSt.com’s Erika Morphy explains,
Companies have been waiting, for years now, for the US Financial Accounting and Standards Board and the International Accounting Standards Board to complete their long-standing plan to revamp lease accounting standards. The two standard-setters have been meeting this week at FASB’s headquarters …and it appears the industry may well be waiting even longer.
What is the real estate industry waiting for? An agreement on details of regulations affecting how companies report their real estate holdings on their balance sheets, as opposed to recording real estate and equipment leases in footnotes. Once these regulations are implemented (whenever that may be), companies will have to report lease liabilities directly on their books, with all other income and debt for that period, which will significantly affect portrayals of the companies’ fiscal health. I don’t know all the details of the pending lease-accounting regulatory changes–most of it’s really boring and I practically fell asleep reading about it–but I will attempt to describe the most salient parts of the regulatory changes and their implications for the commercial real estate industry:
- In an effort to mitigate the damage to their bottom line, companies will be motivated to decrease their real estate and other leasing liabilities.
- They will be incentivized to sign shorter-term leases in order to decrease the obligations reported on their books.
- For many large companies, this will result in a de facto merging of real estate and accounting operations as the two become increasingly intermingled, reports a Wharton Real Estate Review article. This could basically give real estate issues (and concerns about how to mitigate real estate costs) greater profile in corporate decision-making.
It’s unclear if and how this change to bookkeeping will affect real estate activity. Some speculate that office, industrial, and retail landlords will choose to raise rents on shorter-term leases, potentially steering tenant companies to other landlords or leading them to decrease their real estate footprint.
This is pure speculation, but I wonder if increased corporate concern for real estate will result in a greater interest in owning rather than leasing real estate? It’s a long shot, but if accounting regulations deter companies from holding long-term leases, maybe this will instead encourage them to buy properties and turn their real estate into an asset (an expensive one, admittedly) rather than a burden on their balance sheet.
It’s a stretch, I know. Still, real estate can be extremely valuable to even a non-real estate company. For one thing, corporate property holdings offer greater stability through diversity. Likewise, real estate can do much to anchor a company or provide a much-needed capital injection when times are tough. Heck, W.P. Carey (NYSE: WPC) made an entire specialized industry out of corporate real estate sales by pioneering the sale-leaseback strategy, in which it acquires and rents back major CRE assets for the likes of the New York Times, Siemens, State Farm, Blue Cross Blue Shield, KBR, TW Telecom, and U.S. Airways.
These sale-leaseback deals can be extremely valuable to corporate sellers/tenants, since they receive a generous capital infusion to put toward paying down debt, acquiring other assets, or expanding their operations in other ways. It’s even more lucrative for W.P. Carey, which has the luxury of selling off the property years down the road at what is often a substantial profit–sometimes selling the property back to its corporate tenant for many millions more than the REIT originally paid.
Of course, real estate can also be an essential tool with which to get a company out of financial trouble. Take Sears (NASDAQ: SHLD), for instance. Struggling for years due to declining sales, a poor reputation, and downright depressing stores in many markets, the storied retail giant is attempting to get on its own two feet once again. To this end, Sears Holdings CEO Eddie Lampert and his team have separated many of the company’s real estate holdings into a separate entity, rebranded (away from the Sears name and its stigma) as Seritage Realty Trust, which is tasked with divesting a real estate portfolio valued at between $4 billion and $7 billion. Will the strategy get the company back on its feet? It will certainly take more than a portfolio sale (even one of this magnitude) to bring the company to a place where it can compete with the likes of Target, Walmart, and Costco. Still, the company holds a great deal of enviable retail locations: if the proceeds don’t reinvigorate Sears’ performance, nothing will.
Author: Raymond T. Cirz
