A few weeks ago, one of my clients had an issue where a landlord gave them a proposal to lease space and the client accepted the proposal.  The proposal was at an aggressive market rate with a significant, although not exceedingly unusual, improvement allowance.  The landlord group is a large institutional investor fund with millions of square feet of prime Class A and B office space.  The tenant is a large national firm with strong financial statements.  This particular building happens to be about 40% vacant.  "Send us a lease document for review", we told the landlord agent.  We waited, and waited, and the document never showed up. 

Finally this week, we called the managing partner for the landlord.  "Our partners won't approve the deal", said the managing partner.  Now this can only mean a few things:

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I'm not crazy about condominiums.  Here's why:  Other people (the condo association - which is often controlled by a very small group of individuals) get to vote on how to spend your money.  Some of those choices may not add value for you or to your property.  Operating expenses on leased commercial property work the same way.  The management company, which is the property ownership or someone under their direct control, gets to decide what expenses get passed through to the property tenants.  So what expenses do they pass through?  Every single one that they can possibly get away with.  There are only two methods of protection for tenants, and I'd estimate that more than half of all leases don't fully take advantage of them.

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Just a quick mention in case you have not yet read your recent issue of CFO Magazine that had an article titled, Balance Sheet Blues, you can read it here.

Every finance executive and corporate real estate manager should be following and preparing for the upcoming change of operating lease to capital lease classification.  See my prior posts.

As a follow up to my previous post regarding the upcoming reclassification by FASB of operating leases to capital leases, which you can read here, I'll outline a general strategy that companies can use to  minimize the reporting impact and unpleasant surprises.  Here's what I recommend as a checklist of Top Ten Operating Lease to Capital Lease Actions:

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For the last 35 years, public companies in the U.S. have reported lease obligations differently that other countries, not unlike the way that we stubbornly hang on to English measurements while most of the rest of the planet uses the Metric system.  That is about to change, and change can be painful. 

Here is the premise of the change:  Virtually all leases will be treated as Capital Leases rather than Operating Leases.  Lessees must account for their right to use a leased item as an asset and their obligation to pay future rental installments for that item as a liability.  Simple enough, right?  Remember, this is written by the Financial Accounting Standards Board.  They do nothing simple.  Fortunately they also move with all the speed of, well, the government.  This will give proactive corporations the opportunity to position themselves to avoid pitfalls and structure their future transactions to their advantage.  The discussion paper, which you can view here, is over 100 pages thick. 

I warned of the impending issue back in 2007, in my article titled, The Death of Operating Leases.   Here are some considerations: 

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I had lunch last week with Harry Dent, the Harvard MBA economist and NY Times bestselling author, to discuss the impact that the age shift of the population will have on commercial real estate. For those of you not familiar with Harry's work, he's written a number of books including The Great Boom Ahead in 1993, The Roaring 2000's in 1999, and The Next Great Bubble Boom in 2004. Each of these books detailed well in advance the enormous gains in both stock and real estate markets that we experienced and their eventual collapse. While predicting the confluence of so many forces on the economy is not an exact science, Harry nailed the overall concepts and general timing of both the run up and downfall of these markets. Unfortunately for the U.S. economy, the title of his latest book, The Great Depression Ahead, gives away a bit of the plot of what is in store for us.

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Even when the economy was absolutely booming, we advocated a lean and mean approach to real estate. That's why this blog is titled, "Less is More". Now however, many political obstacles to reaching Lean & Mean objectives have been removed. The corporate real estate director (in virtually all corporations large enough to have corporate real estate directors), now likely has complete buy-in from both the finance and operations executives AND field staff.

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Many companies believe that either 1) They must live with whatever terms are stated in their existing lease until it expires or, 2) They can go to their landlord, tell them that they can't afford to pay their existing high rental rate, and the landlord will willingly drop their rent to current market rates. Which is correct? Well....generally neither, exactly as described. Here's how to get the most benefits:

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In three separate incidents that I've witnessed recently, landlords have demonstrated their growing financial desperation. Two of the cases involved clients moving out of a property and debate over the "reasonable wear and tear" condition of the premises on vacating. The other issue involved a proposed new lease with a rider describing the required condition in which the space must be returned - in essence describing most of the preparation that a landlord would typically do to prepare a space for a new tenant.

The underlying issue here is not about the tenant's treatment of the space, it is about the landlord's increasing financial pressure to preserve precious cash.

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It is a great time to be a tenant, and here is another example. Because almost all lease renewal options are written with the assumption that rental rates will climb forever upwards, we're seeing some interesting effects as rates tumble.  Like many stock options, some renewal options are literally not worth the paper they were written on. However, declining markets have made some usually unattractive renewal options have new value. Here's why:

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Here's a simple technique that has saved several dozen of our clients literally millions of dollars in lease costs, and is very applicable to the changes happening in today's market. I call it the Tape on the Floor Option.

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As you might guess, recently we've been much more active on both sides of subleasing transactions.  Almost every market search includes a sublease option or two, perhaps more.  If you are looking for space, should you bite?  They may not be worth the trouble.  Read on.

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Recession, recession, recession!  There, I said it.  We're in one.  Don't let the government or the landlord reps mislead you.

It doesn't effect all business directly, and is certainly selective in its targeting of particular industries.  Anyone with interests related to residential real estate is getting hammered, and the trickle-down effect is reaching out to financial markets, retailers, and distributors.  The government is trying to bolster home prices and lessen the effects of oil inflation, and the jury is still out on the long term forecast. 

Here's what I like about it:

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In his recent book,The Age of Turbulence, Alan Greenspan compares capitalism to collectivism by remembering a drive that he had in the Moscow countryside in 1989, just before the fall of the Berlin Wall.  There he saw a 1920's steam tractor, which might have been in a museum in the U.S., clanking and belching through a field under a local farmer.  "Why do you suppose they still use that?, Greenspan asked his security man.  "Because it still works?", the man replied.

It is easy to fall into a "real estate rut" just like that farmer.  Are you using your facility the same way a businessperson might have used a similar property in the 1920's?  Perhaps it is time to scrap your steam-engine equivalent and gain some efficiency.

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The world is experiencing rapid globalization and merging of economies and cultures.  In his book, The World is Flat, Thomas Friedman discusses how the internet, modern travel, and communications are commoditizing just about everything.  Where globalization is not happening quite so quickly is in real estate which is still, very much, a local business.  As citizens of the United States, we take property rights for granted.  Ownership is black and white - you either own something or you don't, right?  Well, not necessarily once you leave our borders.

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 For 31 years, public companies have used a rule known as FAS 13 to classify most real estate lease transactions (virtually all leases 15 years or less) as Operating Leases.  Unlike a Capital Lease, the Operating Lease does not appear on the company's balance sheet.

The governing Federal Accounting Standards Board, affectionately known as FASB (pronounced Faz-bee), is currently in the process of scuttling this provision in favor of a new Sarbox-friendly full disclosure plan that will eliminate or greatly reduce the qualifications for Operating Lease classification.

I can see many of the non-accountants out there falling asleep.  So what, right?  WAKE UP!  This is a big deal.

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Whenever I have speaking engagements, I always end with a Q&A session and inevitably someone will ask, "How will the merger between CBRE and Trammell Crow impact the industry?"  My response is usually, "Which part of the industry?"  I'd like to address it here in the hopes that the next person who might ask will read it and save me the time of repeating myself. 

The impact to real estate development and investment segments will be significant in that CBRE now has the development resources to support the supply of investment capital that it has raised, and they've moved into position as one of the top ten owners (not just third-party landlords - actual owners) of office properties.

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An article in the April 2007 issue of CFO Magazine titled "Cleaning up Carbon" addresses the pressure that most corporate users will soon have to face regarding CO₂ emissions.  Peter Breitstone, the CEO of insurance giant AON's Environmental Services Group, says "Each company is going to have to deal with some sort of [CO₂] regulation.  We know that it is coming."  The Investor Network, a coalition of enviro-friendly investors with more than $200 billion in assets recently published a list of 10 major offenders.  The list includes the usual energy company suspects, plus a few you might not expect such as Wells Fargo (the group says that unlike JP Morgan and Bank of America, WF hasn't come up with a plan to reduce carbon emissions from their everyday business practices), and Bed, Bath, and Beyond (Investor Network says the retailer hasn't disclosed its strategies on how to improve energy efficiency).  So has YOUR firm disclosed your strategies on how to improve energy efficiency?  No?  Read on.

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Not too long ago, almost all of my high tech clients would build a server room with raised flooring, Liebert (another client) 24 hour air conditioning, and UPS systems the size of a Hummer.  More often that not, those build outs now look as dated as a wood-paneled earth-toned space with 8' ceilings.  Computing is getting faster, cooler, and frequently, remote.  And the absolute best remote data storage service that I've seen is a simple service called...Mozy.

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Spalding Sports is the largest producer of basketballs in the world.  A few years ago, they asked us to help them expand their west coast distribution center.  At the time, Spalding had 180,000 SQFT of space and estimated that they needed about 40K more for a total of 220K SQFT.  We asked a question:  Why?

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