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]. July | August 2018 39