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Corporate real estate execs before Congress. Could it happen? May 12, 2010

Posted by Bob Cook in Financial Planning & Analysis, Lease Accounting, Profession of Corporate Real Estate.
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A couple weeks ago, as I watched the Congressional interrogation of Fabulous Fab, I was struck by how this young guy, who toiled deep within Goldman Sachs’ 30,000-some-employee corporate hierarchy, had become so quickly notorious. This was not the Chairman or CEO or CFO or any other C-suite exec who was being drilled; this was a guy who was only 28 years old and barely out of grad school when he masterminded the trades that some think exemplify the greed of Wall Street and that landed him before Congress. 

This all got my mind to thinking whether or not a corporate real estate exec would ever be up in front of Congress. It’s clearly never happened before… but the new lease accounting standards are going to place corporate real estate smack-dab in the middle of preparing some of the biggest numbers on company balance sheets – the present value of existing lease obligations. Corporate real estate execs are going to be in the uncomfortable, unenviable, and sometime untenable position of having to attest, to their management, the reasonableness of forward-looking projections regarding existing leases – including hard-to-make assumptions like the likelihood of lease renewal and the likely rental rate at renewal. If their assumptions turn out to be wrong, no one will go back and check — unless, of course, their company ends up in bankruptcy and investors claim the company financial statements were erroneous – in which case – Look Out!

Never before, have corporate real estate execs been front and center on anything quite so large. For many companies, the present value of their lease obligations will exceed the amount of debt they have in the form of bonds, bank loans, etc. These companies are going to look a lot more risky to investors than they have previously. While companies have been showing lease obligation information in the notes to their financial statements, the new accounting will show it right on the balance sheet. And the number is likely to be larger – in some cases, much larger. Presently, companies only report the minimum lease obligations for existing leases (and, again, only buried in footnotes); the new accounting will show the likely lease obligation for existing leases, taking into account likely renewals (and, again, right on the balance sheet). It’s going to be a very large number. Some companies are going to see billions of dollars of obligations appear on their balance sheet.

And what’s going to keep corporate real estate execs up at night is the fact that they are likely to be the ones responsible for making and documenting assumptions that significantly impact the size of obligation recorded on the balance sheet. Fast forward twenty months or so to when the new standards will take effect. Take the case of a ten-year lease costing $1 million per year that has only, say, two years left to run but which gives the tenant the right to renew for another ten years at the same rate. If one assumes the lease is not renewed, $2 million of obligations go on the balance sheet. If one assumes the lease is renewed, then $12 million goes on. Quite a swing. Just imagine the pressure from management who will want the corporate real estate exec to find a way to legitimately opine that the lease will not have to be renewed. And imagine the pressure from auditors who will say “show me the plan” before they sign-off on a no-renewal assumption. It’s not hard to imagine that corporate real estate execs – when they are able to sleep, in spite of all this pressure – will have vivid nightmares of having to defend their renewal assumptions before Congress.

Some corporate real estate execs got a small taste of what it could be like back in 2005 when a slew of companies needed to restate their financial statements due to what-the-SEC-said-was faulty lease accounting. In that situation, though, the problem was one of technical accounting and how companies and their auditors thought leases should be accounted for. The practices that the SEC said were faulty were, in fact, widespread. The SEC set everyone straight, and while there was a lot of egg on faces and hands got slapped, there were no allegations of intentional wrong-doing. There were no Congressional hearings. No corporate real estate execs before Congress.

With the new lease accounting standards, though, corporate real estate will be cast in a new role – an important financial role.  Corporate real estate execs before Congress?  It could happen.

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