March 2010: Commercial News Roundup

News briefs to keep you in the know about the commercial real estate industry.

March 1, 2010

Proposed Accounting Rule Could Fuel Corporate Buying

Even if you're one of those folks who normally leave accounting to the geeks, there's good reason to read up on a proposal under consideration by the Financial Accounting Standards Board. That's because the changes, if approved, could mean a big boost in the number of corporations that want to own their office or warehouse space.

An important modification to the "Statement of Financial Accounting Standards No. 13: Accounting for Leases"—which could become final in early 2011—would alter the way that companies show rent costs on their balance sheets, says Todd Anderson, senior managing director at the Los Angeles office of CB Richard Ellis.

In essence, rent payments would go from being recognized as an operating expense, which doesn't appear on a corporate balance sheet, to a capital expense, which does, thereby cutting into profits. And in the name of financial transparency, it would require corporations to carry a reserve equal to the amount owed over the whole lease term as a balance sheet liability, Anderson says.

From an accounting perspective, it's almost as if you're buying the property, says Anderson. So, if you have to hold the money to cover what is essentially the cost of buying your space, why not just buy it?

If that thinking takes hold, and it well could, there could be a lot of companies eager to buy rather than rent. "The first reaction from companies might be to shorten their lease terms and negotiate for more options to extend their leases. But if a company needs to control the space for 10 years or more, buying may be the best option," Anderson says.

Buying has other accounting benefits as well: If a company puts a lease on its balance sheet, it depreciates the value only over the term of the lease, but if the company owns a building, the depreciation can run the full length allowed for commercial buildings (currently 39 years).

Although changes to SFAS 13 haven't been adopted yet, companies that are now negotiating long-term leases could be subject to the rule's provisions for much of the lease term.

Smaller companies without the resources to buy a whole building may seem to have more limited options in adapting to the revised accounting standard, but you should never underestimate the creativity of the commercial real estate market. "It's very customary in places like Hong Kong to buy a floor of a building. That model could certainly be used in the United States," Anderson says.

To read CB Richard Ellis' white paper on this topic, titled "FAS-talking: Unpacking Real Estate's Impact on Financial Statements," use the search tool at www.cbre.com.


REITs Show Us the Way

Tracking the performance of real estate investment trusts is an effective way to learn about the future direction of the broader commercial real estate market, says Lee Menifee, senior director of global strategy for CBRE Investors in Los Angeles.

What exactly can REIT share prices tell us?

Because REITs are publicly traded, the general direction of their share prices tends to reflect market repricing more quickly than the private market does. REITs have to provide commentary on their performance to analysts on a regular basis, so there's more visibility and more frequent adjustments in price than with privately held properties. Keep in mind that I'm talking about trends in REIT prices, not daily or weekly fluctuations.

Did REITs predict the current problems that the commercial real estate market is experiencing?

They did. As REITs have become a bigger part of institutional real estate ownership in the United States, Europe, and parts of Asia, they've become a much more effective indicator of market direction. At the start of the market downturn, REIT prices in the United Kingdom started to fall six months ahead of private indices. In the United States, prices started to decline about 12 months ahead of the general market. In both cases, REIT share prices started to reflect the weakness in leasing and the deterioration of rent growth earlier than private market indices did.

What are REITs predicting these days?

The recovery of REIT share prices in the summer of 2009 reflected a firming up in property pricing. That doesn't mean that the prices of commercial property or rents are going up, but there's a greater clarity on pricing and a greater sense of what properties are worth. This stabilization of pricing is more apparent in REITs. You can't say that if REITs go up today, the commercial real estate market will recover in any specific amount of time, but the recent increase in REIT share prices is a good indicator that recovery is on the way.

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