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Lease Accounting Fisticuffs at Corenet…. April 26, 2010

Posted by Bob Cook in Financial Planning & Analysis, Lease Accounting.
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Well, maybe it didn’t really come to blows. I’ve been told, though, that the scene last week with JLL presenting the new lease accounting at the Corenet Global Summit was a little like the Blues Brothers singing behind chicken wire at Bob’s Country Bunker. I imagine the FASB guys on the panel were taken aback a bit. Little did they know about the High Animosity (now here’s a good storyline for Mel Brooks) between corporate real estate groups and their sister accounting and finance groups.

 I’d be interested in hearing some accounts of the episode.

Am I the only one bummed that Barbie isn’t a corporate real estate exec? April 21, 2010

Posted by Bob Cook in Profession of Corporate Real Estate.
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Barbie apparently is going to be a computer engineer or – if young girls have their way – an anchorwoman. “Corporate real estate exec” wasn’t even on the ballot. Surprise, surprise.

Is it too early to begin lobbying for her next career change? Probably not, she’s had 126 different careers in 50 years;  she’s clearly a malcontent job-hopper. If only we could get to her and let her know about the joys of corporate real estate, who knows, she could be joining CorenetGlobal by the end of the year.

Icelandic Volcano: Another Black Swan showing serious need for business continuity planning… April 20, 2010

Posted by Bob Cook in Business Continuity Planning.
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How many black swans are out there? In the last decade we’ve seen some doosies: 9/11, SARS, Hurricane Katrina, the Eyjafjallajokull Eruption. Each has occurred on a spot on the globe – New York, Guangdong, New Orleans, Iceland – and yet each had far-reaching consequences, affecting companies and economies around the globe. This latest one has disrupted both business travel and supply chains everywhere. As the world becomes increasingly interconnected and increasingly complex (technologically, politically, socially, economically) big local disasters end up being big global disasters. Everyone gets affected. 

Unfortunately, it’s likely the unlikely will continue to occur.

Tax Week Special: Dare we ignore taxes the other 51 weeks? April 12, 2010

Posted by Bob Cook in Financial Planning & Analysis, Silicon Valley.
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It’s tax week. Oops. There goes 35% of my marginal income – or actually even more considering the state tax. “Why,” I ask myself rhetorically, “did I bother working those last few hours last year? I should have left for the New Year’s Eve party early.”

Likewise, I wonder, why do corporations burdened with a 35% Federal tax and additional state taxes fret so much about all the little cost savings they pursue when billions of dollars flow out the door as tax, sometimes with nary a look? Tax expense is one of the largest expenses companies have – yes, sometimes more than real estate and facilities, sometimes even more than salaries – yet companies do a miserable job of managing it. Most don’t even really try.

Many people think tax expense is not manageable, that the amount you’ll pay is predestined, inevitable – that you’re going to send 35 percent of your before-tax-income to the Feds and whatever percent to your state, no matter what. Not true. If it were, the tax paid as a percent of income-before-tax would be pretty much the same across companies. But take a look, below. I present the overall three-year-average tax rate shown on the income statements of some large California companies. All are headquartered within a few miles of one another, and all are in high-tech such that they are inherently similar (albeit, they have over time chosen different models for production, geography, financing, etc – but that, of course, is the point!)

 

Income-before-tax (3-yr average)         Tax (3-yr average) Tax as % of Income-before-tax
HP 9,688,333 1,937,333 20%
Cisco 9,136,333 1,963,333 21%
Google 6,636,255 1,652,580 25%
Intel 7,518,667 1,973,000 26%
Oracle 7,218,000 2,088,667 29%
Apple 8,673,000 2,723,333 31%

 

There’s an 11% point spread from high to low. Apply that to a multibillion-dollar-plus income-before-tax and you’re talking serious money. Granted, the GAAP accounting for taxes may skew things a bit as do things like tax losses being carried forward (although, the 3-year average should ameliorate this), but it’s nevertheless clear that the tax rate is not inevitable and that some companies pay much less than others. Whether the large spread in their tax rates is caused by conscious tax-planning or dumb luck can’t be known, and one shouldn’t jump to the conclusion that high-tax-rate companies are doing a poorer planning job because they might be making intelligent choices taking into account tax and other factors. The wide point spread should, though, open one’s eyes to the scope of opportunity available if one were to consciously pursue tax-planning.

(In case you’re wondering: while the Federal plus California marginal tax rate for corporations is 44%, the threshold for reaching this rate is very low, so the lower-than-44% overall tax rate of these companies cannot be explained by an overall-vs-marginal-tax-rate argument; there are other things going on that cause it.)

A company’s tax rate is determined by the business decisions – the big ones and the many, many small ones – made throughout the company. The way to manage income tax expense, therefore, is to routinely take taxes into account in decision-making – or at least for those decisions that can be identified as impacting tax.

That’s easier said than done. Tax analysis can be complex, and more importantly …. few, if any, managers in a corporation have an incentive to take taxes into account in decision-making. Budgets are almost always before-tax with bonuses based on before-tax performance. (I might add that they’re also based on “before-capital-cost” budgets and performance goals – an even bigger topic that merits a future blog post.)

Many of the decisions impacting a corporation’s tax rate have corporate real estate execs as participants – sometimes even as decision-makers. Location decisions are obvious examples. Should the facility be on this side of the state line or that? Should we own there or lease? Invest more there or here? These decisions affect individual state’s claims on how much of a corporation’s income is from their respective states and hence how much income is taxable in their state. It can make a big difference. Some state’s (NV, WY, SD) have no corporate income tax at all; some have rates close to 10% (PA, CA).

Even more obvious examples of how location decisions affect tax position are decisions to locate facilities overseas to significantly-lower tax-regime nations – Singapore and Hong Kong come to mind – particularly if the plan is to never bring the profits back to the U.S.

There are also everyday financial-type decisions being made in corporate real estate departments that affect income taxes. In these departments, it is convenient to assume that all cash flows and all P&L statement numbers would be affected by taxes similarly so that an an after-tax analysis would simply echo that of the before-tax analysis and be unnecessary – but this is not always true. Consider for example, the decision to purchase Bldg A or Bldg B which are priced identically. Before-tax, the economics of both seem identical. If, however, the allocation of price between land and building differs between the two buildings, an after-tax analysis would show them to have different costs. The one with the lower land value and higher building value would be less expensive because the deductible depreciation expense would be higher.

There are many other situations where before-tax and after-tax analysis point to different courses of action – from big decisions such as own-vs-lease to common decisions such as whether to accept a landlord’s offer to pay for tenant improvements. It is unfortunate that so much effort often goes into fine-tuning before-tax financial analysis when it leaves out such a weighty thing as tax. Before-tax analysis is ok as a preliminary, quick-and-dirty, back-of-the-envelope calculation based on WAG’s, but …. for a final decision?

Do you have your SOX-compliant portfolio plan yet? April 5, 2010

Posted by Bob Cook in Alternative Workplace Strategies, Financial Planning & Analysis, Lease Accounting.
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I’ve been writing about the impact of the new lease accounting standards to be set by FASB and IASB.  By June of this year the Exposure Draft outlining the standards will be in place with compliance likely to be required in late 2011 or early 2012. Corporate real estate – both strategy and process – is going to be mightily affected.

One aspect of the standard, in particular, is going to have far-reaching consequences – namely the accounting for leases with options to renew. This accounting is going to force corporate real estate departments to have documented portfolio plans. And these are going to have to be diligently created plans, created with SOX-compliant processes, that pass muster with auditors.

Here’s the background: The present value of future lease obligations will be going onto balance sheets. Most companies won’t like this because it will spotlight their financial obligations to landlords and negatively impact some measures of profitability such as Return on Assets. But here’s the interesting wrinkle on the present value calculation: the amount of lease obligations has to be based – not just on the present term of the lease but – on the likely lease duration, taking into account optional renewal periods.

Impact on strategy and process: That means that each quarter, corporate real estate departments are going to have to state what they think will be the likely lease durations for those leases with options to renew. Upper management is going to be pushing to make non-renewal assumptions, where legitimate, particularly for large leases. Auditors, though, will be scrutinizing any assumptions that renewal options will not be exercised and are probably going to require that formal portfolio plans, supported by the affected business units, be in place to substantiate renewal assumptions. And they’re going to want to review the processes used to create those plans.

How Corporate Real Estate Execs lives will change: Real estate planning is going to have to look ahead more than it typically has. This is going to be a challenge for corporate real estate departments in terms of staffing, but even more so in terms of getting business units to work with them on developing longer term plans.

For corporate real estate departments, this is “good news / bad news”. The “good news” is that they will gain CFO support in their efforts to get business units to do longer-range real-estate planning with them – something which many corporate real estate execs would like to do, but which business units are usually loathe to do.  The “bad news” is that corporate real estate departments are going to be in the “hot seat.” They’ll have responsibility to prepare a plan, but they’ll be dependent upon the cooperation of others across the enterprise to prepare them. Not an enviable situation.

So what can corporate real estate execs do? As always, starting early will help. Corporate real estate execs have to start tackling this issue now. They can lay out their process for developing portfolio plans, identify the major leases or collection of leases that deserve scrutiny, understand what options to renew exist, educate themselves about the new accounting standard, begin to educate their internal clients about it, and in general, get on with the business of portfolio planning.

 Other posts on lease accounting:

Beware new lease accounting guidelines coming

IASB confirms June 2010 date for lease standard exposure draft

Cisco’s Real Estate Valuation Dilemna: How much is enabling face-to-face collaboration worth? April 5, 2010

Posted by Bob Cook in Alternative Workplace Strategies, Financial Planning & Analysis, Real Estate Markets, Silicon Valley.
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Last week the San Jose Mercury News reported that the State of California is moving along on its efforts to sell the last large parcel of the Agnews Development Center property – 86 acres in north San Jose. See “Last of Agnews property up for grabs”.

While other state agencies, county government, local government, and school districts have first dibs on the property, if none of them bite, it’ll be offered to tech company Cisco which has an option, dating back to 1996, to purchase the land for $90 million. If Cisco doesn’t bite, the property will be made available to the public.

Cisco might very well bite. The property is adjacent to its giant, sprawling headquarters campus and would fit Cisco’s modus operandi which has been to consolidate virtually all of its 11,000+ Bay Area employees on this campus. If it thinks it might want to expand its employee population in San Jose at some point in the future, the Agnews site might offer the last chance to expand its campus with contiguous land.

That’s a big “if”, though, because in recent years, Cisco has been expanding its R&D efforts considerably oversees — most notably in Bangalore where it has 6,000 employees and aims to have a total of 10,000 employees in a few years. This overseas expansion has, arguably, been at the expense of growing R&D and other jobs in San Jose, and might be an harbinger of where job growth would be for the company in the future.

Assuming, though, that Cisco wants the land, the issue it needs to deal with is price and bidding strategy. While it has an option to purchase the site at $90 million, the California General Services Administration estimates the value of the land to be only $60 million. If Cisco were to exercise its option, it seems, on the surface, that it would overpay.

But if Cisco doesn’t exercise its option and chooses, instead, to try to be the successful bidder in an open bidding process so it can get the property for something closer to $60 million, it risks not being the successful bidder at all. This is particularly true because price won’t necessarily be the State’s only criteria for selecting the winning bidder. It might, for example, give preference to bids from developers who would convert the site to housing, the promoting of affordable housing being one of the State’s goals.

So that’s going to make Cisco think long and hard about passing on its option to buy. Some might say that the 50% premium it would have to pay above the site’s estimated value is too high, but that estimate of value does not take into account that this property is probably a lot more valuable to Cisco, if it thinks it needs the expansion space, than to anyone else.

As one of the world’s most profitable companies (with net income of $6 billion per year, equal to 17% of revenue), Cisco could, and probably should, look at the value of that land differently than would others. If, in fact, the aggregation of so many employees near one another so as to maximize face-to-face interactions is an important feature of what makes Cisco tick (and it seems that the company’s decision to aggregate so many employees in one place indicates that it does see this as an important feature — and if it wants to provide for future growth — then its valuation of the land should be based on an evaluation of the incremental profit that the company would derive from expanding jobs in San Jose. It should not be based on any of the traditional land appraisal techniques. In fact, this methodology of basing value on what incremental benefit the property would bring to the company would be in line with how companies typically evaluate whether their owner-occupied properties are impaired and should be written down on their balance sheets. Companies typically do a test to see if the cash flows likely to be generated from the enterprise substantiate the property values on their books. If it does, then there’s no write-down — even if the aggregate of all the “market values” (using traditional appraisal techniques) of the properties is less.

Cisco’s high level of profitability would, I guess, easily allow it to justify “overpaying” for the Agnews site. By how much is difficult to judge, but for a company with net income of $6 billion per year, a $30 million premium would not seem too much to me. What Cisco would have to do is think through the value of being able to expand its campus onto contiguous land. Ultimately, that’s a judgement-call on the value of face-to-face communication – a big picture question if there ever was one. Be sure it’s not just a calculation of how much time would be saved in getting people together because they don’t have to drive very far. Instead, the true value would be based on the benefits of the face-to-face meetings – some serendipitous – that just wouldn’t happen at all if folks were not so proximate to one another. These may be just the type of interactions that may be at the core of Cisco’s success.

The irony of all this, of course, is that Cisco makes networking gear that facilitates virtual meetings, remote work, electronic communications, etc. It advertises how it supports “The Human Network” through other-than face-to-face communication (although it’s telepresence product, I suppose, sort of supports face-to-face encounters for those who can afford it.) These analogies aren’t quite on target, but: Cisco’s placing a high value on “face-to-face” would be like McDonalds serving only health food in its company cafeteria, like Nike not allowing employees to exercise at lunchtime, and like the State of Kentucky outlawing smoking.

IASB confirms June 2010 date for lease standard exposure draft April 1, 2010

Posted by Bob Cook in Financial Planning & Analysis, Lease Accounting.
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In a webcast, yesterday, the staff of the International Accounting Standards Board (IASB) confirmed that it plans to issue an Exposure Draft of the new lease accoounting standards in June of this year. The final standard is scheduled to be issued in the second quarter of 2011.

As I’ve noted previously, these standards are going to have wide-ranging impact on corporate real estate — affecting everything from strategy (own-vs-lease, lease duration) to processes (corporate approvals, cash obligation forecasting, lease administration, SOX-compliance) to staffing/training needs (financial/accounting literacy).

The IASB is creating the new standards as a joint project with the U.S.-based FASB. The new standards will apply to companies worldwide. You can learn more on the IASB’s project page.

Virtual Meetings vs Travel: How big advertising bucks are influencing alternative workplace practices April 1, 2010

Posted by Bob Cook in Alternative Workplace Strategies, Company Case Studies.
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The battle’s raging. On one side: the Tech Industry – Cisco, AT&T, Polycom, and the like – touting the benefits of virtual meetings. On the other side: the Travel Industry – Hyatt, American Airlines, British Airways, and their brethren – touting the benefits of live, personal encounters.

The battle is being waged with advertising. At stake is how company dollars are apportioned between tech budgets and travel budgets – and in the balance: the future of virtual meetings.

The tech companies started the battle a few years ago as they began advertising things like Cisco Telepresence and Webex on-line collaboration tools. The travel industry didn’t at first appreciate the attack on their business. Then, though, the Big Recession set in, and company execs around the world issued edicts to limit travel spending. Managers found they could hold meetings virtually, achieve cost savings, save time – and, as an added bonus, not miss their son’s little league games. Travel spending plummeted…. as did travel-industry revenue.

Hotel chains and airlines learned that virtual meetings posed more than an idle threat, and they are now counter-attacking, spending heavily on advertising the business benefits of business travel. They’re citing research about how important face-to-face contact is. Hyatt ads proclaim, “Great happens when people get together.” American Airlines ads say, “Eye Contact. Your most underrated skill set.” and British Airways says: “Be there face to face.”

We’ll have to wait and see how this all plays out. Arguments from both sides are being made by well-funded voices, by some of the largest advertising budgets on the planet. Certainly, both positions – travel is bad, travel is good – have merits, and both virtual meetings and business travel are likely to be here to stay. The question is: to what extent will virtual meetings curtail business travel?