TRIRIGA Insights

Last week hurricane Alex slammed into the northeast coast of Mexico; bringing with it winds of over 100 miles per hour. Although Alex ranked as a relatively low intensity Category 2 hurricane, the storm still caused over $1 billion of damage and affected hundreds of thousands of people. Experts predict that this is just the start of an unusually strong hurricane season. The National Oceanic and Atmospheric Administration (NOAA) predicts an “extremely active” season with between 8 to 14 hurricanes. The Tropical Meteorology Project at Colorado State University’s Department of Atmospheric Sciences estimates that there is a 76 percent chance that a hurricane will hit the US coast between June and November of 2010. This probability is more than 20 percent greater than the average hurricane season.

Figure 1: Hurricane Alex.

Given the very real risk of hurricanes, earthquakes and other disasters, organizations must be prepared to deal with the potential damage and business disruption that natural and manmade disasters can cause. Effective disaster recovery and business continuity plans are critical to minimize business downtime and property damage. A major component to these plans is facilities. Real estate and facilities management departments must have access to facility information critical to emergency preparedness and disaster recovery management. According to industry analyst, Mike Bell, a business continuity plan must include the following information related to facilities:

• Robust information on facility capacities, contract obligations, and values
• The location, identity, and roles of essential staff, and an established contingency plan for these personnel in the event of a business disruption
• Contingency plans for mission critical facilities in the event of a catastrophic business disruption
• Facilities disaster recovery processes that align and support enterprise business continuity plans

Unfortunately, many organizations struggle with inflexible and cumbersome legacy systems that have incomplete and inaccurate data, poor integration, and a lack of pre-defined processes.

Integrated Workplace Management Systems streamline emergency management

An Integrated Workplace Management System (IWMS) streamlines the creation and implementation of disaster recovery and business continuity plans. IWMS provides critical insight into mission-critical facilities and delivers the centralized repository of essential facility information, processes, and procedures necessary for an effective emergency response.

To learn more about how IWMS delivers the capabilities to support your organization’s disaster recovery plans, read Integrated Workplace Management System – A critical tool in business continuity and disaster recovery management, a whitepaper authored by leading industry analyst Michael Bell.

The new lease accounting standards will increase the importance and role of Corporate Real Estate professionals.

Under the proposed lease accounting changes, Corporate Real Estate (CRE) professionals will be tasked with new and critical responsibilities related to the preparation of financial statements. To comply with the proposed lease accounting standards, CRE professionals must develop, maintain and supply accurate lease information, and create new portfolio planning processes in order to inform the forward looking assumptions necessary under the new lease accounting standards. See Figure 1 below.

Figure 1: New Responsibilities for Corporate Real Estate.

In the third and final session of TRIRIGA’s webinar series, The New Lease Accounting Standards and You, Bob Cook, Real Estate and Financial Strategist, provided insights into the increased responsibilities for Corporate Real Estate professionals including, but not limited to the following:

• Maintenance of complete, accurate and timely lease data
• Process design for hand-off’s, data checks, global processes and SOX-compliant processes
• Technology integration requirement plans for re-designed processes, including the need for global access and/or entry, database of record and getting IT support for new and enhanced technology
• Assumption-making processes, long-term planning, alternative workplace strategy, rights to renew and ethics training
• Creation and management of an effective communications program in order to streamline understanding of all downstream effects

Figure 2: Increased Responsibilities for Corporate Real Estate.

To learn more about how the new lease accounting standards will change your processes and strategies, click here to view the TRIRIGA webinar series, The New Lease Accounting Standards and You.

The intent of new lease accounting is to shine a spotlight on the lease obligations of companies to make them more visible to investors than they are today. Under proposed changes to lease accounting rules, the SEC estimates that $1.3 trillion of operating lease obligations will be added to balance sheets. All companies with leases will be affected, some more than others, and some industries more than others. While retail companies will have their balance sheets affected most, the impact on non-retail companies might be the most surprising. See Figure 1 below.

Figure 1: Future operating lease obligations to go on balance sheets.

The spotlight on lease obligations will lead to a spotlight on the policies, practices, processes and people who manage real estate assets within U.S. companies. In the second session of TRIRIGA’s three-part webinar series, The New Lease Accounting Standards and You, Bob Cook, Real Estate and Financial Strategist, provided insight into the challenges created and how companies must re-think their corporate real estate strategy under the proposed standard.

New Challenges:

New lease accounting rules require that all leases be recognized as capital assets and require an adjustment in the way they are recognized on the Profit and Loss Statement (P And L) of companies. Rather than a “Rent Expense”, companies will recognize lease obligations as “Depreciation” and “Interest” expenses. While payments to landlords remain the same, for accounting purposes they will be divided into principal and interest payments – similar to a self–amortizing loan.

As a result, the interest component will be greater in the early years than in later years. Figure 2 illustrates how the proposed lease accounting changes will have a negative effect on earnings during the first half of the lease term.

Figure 2: Example lease under new accounting standards.

Implications on Real Estate and Financial Strategies:

The longer the lease term, the worse the problem! A 5-year lease (or one with 5-years remaining at the effective date) will increase the lease obligation by 9.52% in the first year, while a 15-year lease will increase the lease obligation by 23.02% in the first year of new accounting rules.†

Therefore, companies must re-evaluate real estate and financial strategies in the context of new lease accounting standards. Traditional Own vs. Lease strategies may flip based on a company’s focus on Return on Assets (ROA) and EBITDA, or P And L impact. See Figure 3 below.

Figure 3: Strategy Re-Think: Own vs. Lease.

Similarly, corporate real estate strategies may change relative to lease term. Long-term leases may look more attractive to companies that previously looked to avoid increases to the balance sheet, as all leases will be capitalized. Short-term leases may look more attractive to those companies eager to avoid heavy P And L expenses in early years. See Figure 4 below.

Figure 4: Strategy Re-Think: Short vs. Long Leases.

To learn more about the impact and preparation required to comply with the new lease accounting standards, click here to view the second session of the three-part webinar series, The New Lease Accounting Standards and You.

† Assumes a 6% Discount Rate

More than 100 Corporate Real Estate and Finance professionals registered for the TRIRIGA’s New Lease Accounting Standards and You webinar series in order to understand and prepare for the anticipated lease accounting changes. In the first of the three-part webinar series, Bob Cook, Real Estate and Financial Strategist provided insights to the major implications that the new lease accounting standards will have on corporate real estate strategy, processes, and internal budgeting.

In this thoughtful presentation, Bob outlined the steps everybody involved in Corporate Real Estate will need to take in order to prepare for the new lease accounting changes:

1. Prepare for the spotlight- With an estimated $1.3 trillion of new assets being added to the balance sheet of major companies, the new standards will shine a huge spotlight on corporate real estate; and result in increased scrutinized by CEOs and CFOs.

2. Understand the budget shortfall- Permanent ratcheting up of lease expenses will create an estimated 5-15% increase in contribution to the Profit and Loss (P And L) of companies.

Figure 1: Lease accounting changes will create impact on income statement

3. Re-think your strategy- The new lease accounting standards will financially impact your current real estate strategies. As companies re-asses their real estate strategy, companies must understand the impact of ownership and term.

Figure 2: Lease accounting changes will force a rethink in real estate strategy

4. Consider the downstream effects- New processes for each downstream effect will need to be implemented to conform to new lease accounting standards.

Figure 3: Lease accounting changes will impact downstream processes

5. Prepare for compliance challenges- New tools, technology and personnel will be required to create, test and implement processes to be compliant with both the new lease accounting standards and SOX.

6. Evaluate leases based on no grandfathering- Leases signed today will follow the new lease accounting standards on the effective date which means that the new lease accounting rules affect today’s decisions.

7. Prepare for the leadership gap- The new lease accounting standards create a challenging multi-functional and cross-business unit project in which ‘point’ person(s) must be assigned.

To learn more about the changes, impact and preparation required to comply with the new lease accounting standards, click here to view the first of the three-part webinar series, The New Lease Accounting Standards and You.

In the next session of this series, Bob Cook will provide insights to the strategic and practical implications of the proposed lease accounting changes. Click here for more details.

Obama asks Federal agencies to “accelerate efforts to identify and eliminate excess properties.”

On Thursday, June 10, 2010, President Obama issued a memorandum that directs Federal agencies to eliminate excess properties and use existing properties more effectively. This directive would save $3 billion by 2012 and aligns with the administration’s increased focus on cost reduction and environmental stewardship throughout the Federal Government.

Real property assets represent one of the best opportunities to save costs and reduce carbon emissions. The Federal Government’s real property portfolio consists of nearly 900,000 buildings with a total area of almost 3.3 billion square feet †. According to the Office of Management and Budget (OMB), the Federal government has more than 20,000 properties that are designated as excess ‡ and more than 55,000 properties that are partially or completely vacant. Besides simply selling excess and vacant facilities, the administration has asked agencies to optimize the use of real property assets by addressing utilization and occupancy rates, operating costs, and energy efficiency. These combined efforts support the administration’s initiatives to reduce costs and improve environmental performance.

First, since real estate expense is often a top-three operating expense item, disposal of unneeded real estate provides one of the most effective ways to reduce costs. For example, General Electric reduced facility costs by more than $1 billion over the last seven years through a concerted space reduction effort. Through a similar program of space management and reduction, the Obama administration expects a reduction in facility costs of $3 billion by the end of 2012. This objective aligns with a recent memorandum from the Office of Management and Budget (OMB) directing non-security Federal Agencies to reduce 2012 budgets by at least five percent.

Secondly, given that buildings are responsible for a large percentage of the Federal Government’s carbon footprint, disposal of vacant facilities and increased utilization of existing facilities provides a critical component to meeting GHG reduction goals. Based on conservative estimates, a 3 percent decrease in real property inventory would equate to a reduction in energy costs of almost $80 million per year and a reduction of GHG emissions of almost half a million metric tons per year. This opportunity supports the Federal Government’s commitment, based on Executive Order 13514, to reduce GHG emissions by 28 percent by 2017.

In a recent memo discussing budget reduction initiatives, the Director of the OMB, Peter Orszag, wrote “agencies should not simply reduce spending across the board. Instead, agencies should aim to restructure their operations strategically.” Similarly, a strategic approach is needed to reduce and optimize real property assets without impinging on the effectiveness of agency operations. In addition to identification and disposal of excess assets, agencies are encouraged to eliminate lease arrangements that are not cost effective, pursue consolidation opportunities within and across agencies, and increase occupancy rates through innovative space management and workplace arrangements. In order to apply these tactics effectively, agencies need tools to fully manage the current portfolio and, more importantly, to create an accurate forecast of future space requirements. With this information, agencies can create a strategic plan to increase the effectiveness of real property assets which contribute to Federal cost reduction and environmental performance goals.

† Federal Real Property Report, August 2009, FRPC
‡ According to the Federal Real Property Council, “Excess” buildings have been formally identified as having no further program use of the property by the landholding agency.