Commercial Investment Real Estate July/August 2018 | Page 41
As a result, “You’re going to have more users who want
to own their own buildings as opposed to renting,” Cal-
lahan says, who is also president of First Colony Finan-
cial Corp. in Atlanta. “When you own, you do not have
an obligation for such things as security deposits, tenant
improvement costs in excess of landlord allowances, and
prepaid rent.”
Sweeney agrees, to a point. “The owned-versus-lease
decision will certainly change, on the margins,” she says.
“So for companies looking to build and occupy single-tenant
core assets, a new headquarters, or manufacturing facil-
ity, they may choose to own because it probably becomes
a long-term asset, and if the asset is going to be on the
balance sheet anyway, they might look to own it. But for
most tenants and most landlords, it really won’t impact the
decision that much. Most tenants are in multitenant build-
ings, and a multitenant landlord is not going to convert
his building to condos and rejigger all that ownership as
occupancy changes.”
Implementation Approaching
Deadlines for compliance are approaching fast. The lease
accounting upgrades kick in on December 31 of this
year for public companies, and a year later for all other
organizations. (CECL kicks in on December 15, 2019.
See Sidebar.) As Callahan and Sweeney indicate, those
dates will trigger both a rethinking of the lease-versus-
own question and a new dynamic between real estate and
finance departments.
“This will decrease build-to-suit activity,” says Joe Mura-
tore, CCIM, principal and co-founder of NAI Benchmark
in Modesto, Calif. “Companies like Walgreens and Panera
Bread that often make use of the build-to-suit model are
essentially achieving off balance sheet, long-term financing
through their leases. With the new rules, they may be better
off owning, as both activities will now be on the balance
sheet and their cost of capital as a direct owner will be less
as they deal directly with lenders.”
Muratore sees new policies coming down from the
CFO’s office to determine for corporate real estate depart-
ments when it’s best to own or to lease. “We will see dif-
ferent thresholds where doing a build-to-suit is the right
model, and thresholds where owning will be the right
model,” he says. “But then it will come back to the cor-
porate real estate department to provide guidance on how
long they are likely to be in that location, how strategic
the site is, and what the likely resale value will be in 10 or
20 years. If it is a strategic, long-term location, then using
a fee-based developer and owning the site for a period of
time before selling it as a leased investment is likely to
provide the greatest return on investment for the occupy-
ing company.”
These decisions will be guided by the general rule that,
CCIM.COM
“When a company owns the real estate directly, they do not
have to pay the developer for his risk and profit, which is
factored into their lease rates,” Muratore continues. “They
can borrow directly from a variety of lenders and their occu-
pancy cost will go down, since the developer/investor profit
layer is removed or reduced.”
Likewise, regarding sale-leasebacks, Muratore says,
“The reason companies do a sale-leaseback is to free up
capital. If I own something, it is already on my books. If
I replace it with a lease, then under the new rules, I may
not get to take it off my balance sheet, which reduces my
incentive.”
Impact of Changes
How severe will these new rules of engagement be? The
answer depends on whom you ask. Conway likens the com-
ing climate to that of another period of disruption in our
not-too-distant past. “A good analogy is the disruption of
the homebuilding industry following the financial crisis,”
he says.
Callahan agrees. “The fact that the entire lease obliga-
tion of the term is being booked as a contingent liability is
going to radically change some balance sheets for tenants.”
But Sweeney doesn’t envision that degree of upheaval.
“We just don’t see that,” she says. “At the end of the day,
it’s about an occupier’s efficient use of capital, and it’s not
every company that’s going to have the financial capacity
to build a big building and own it. And, as I said, a land-
lord with a multitenant occupancy isn’t going to change
their habits.”
She takes a very practical stance when advising her cor-
porate clients: “We have advised them for years to talk
with those they have banking relationships with to make
sure they’re taking these new rules into account. And as
we go through different scenarios, we’ll recommend dif-
ferent structures based on their credit quality and what
their long-term objectives are, corporately and for specific
locations.”
It’s wise advice, and the best practitioners can do is
prepare to weather the coming storm of change, however
severe, with as much of a view to the long-range as pos-
sible. The one constant in this industry is change, and we
all know we’ve weathered worse.
There’s something else we know about this coming year
of transformation. “It’ll be a lot more work for occupiers and
for landlords,” Sweeney says. But will all that work result in
a more transparent and efficient industry? “It really doesn’t
matter. It’ll simply be the way things are.”
John Salustri is editor-in-chief of Salustri Content Solutions,
a consultancy focused on enhancing the web and print
content of a roster of international clients, and was founding
editor of GlobeSt.com. Contact him at [email protected].
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