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Lease Accounting Change Still Coming; Waiting for the Fat Lady to Sing May 15, 2011

Posted by Bob Cook in Financial Planning & Analysis, Lease Accounting.
1 comment so far

FASB and IASB are working feverishly to get their new lease accounting standard out.  They’ve admitted that they’ll miss their target date of June 2011 by a few months but claim to be as committed as ever to reform lease accounting.  Their goal: greater disclosure of lease liabilities.

Over the last few months, the accounting boards have met frequently to “re-deliberate” (which is their word) aspects of the new lease accounting they proposed in their Exposure Draft on Leases issued last August.   They’ve been trying to respond to objections raised in the more-than 700 comment letters they received during the comment period that ended December 15, 2010.  Bit by bit, the boards are addressing concerns raised and making tentative modification to their original proposal.  In general, though, the main tenet of the original proposal … that all leases go on balance sheets … remains intact.  In fact, the strategic and process implications of the new accounting are as big as ever.

So, where are we now?  Following is a summary of the accounting proposal as it now sits.   Be aware, though, that this is a digest.  It only covers main points, and it glosses over the many nuances of these points.

Also, remember: “the fat lady hasn’t sung yet”.  The “Re-Deliberation Opera” is still on and there could be more changes, reversals, and reversals of reversals in the offing.

For more information on the implications for real estate strategy and proceses, see my other posts on the new lease accounting here.  In particular check out an earlier post on “Ten Things You Should Know about the New Lease Accounting Standard” but make sure you read below to understand how the capitalization of optional renewal periods and P&L accounting are still being re-deliberated.

All leases will go on balance sheet.   The main thrust of the new accounting is to require lessees to capitalize their leases and put them on balance sheets … as both right-of-use-assets and lease liabilities.  A lease will be capitalized in an amount equal to the present value of its future lease obligations, discounted at the company’s incremental borrowing rate.  There has been little opposition to this idea of putting leases on balance sheets, and it will undoubtedly happen.

Don’t be confused about talk that the accounting boards are considering the possibility of allowing two types of leases: “finance leases” and “other-than-finance leases”.  First, the boards are second-guessing their idea of having two types of leases, and so the concept might not survive.  Second, though, if the concept does survive, know that the reason the boards are considering two types of leases is only to allow two different types of expense recognition for P&L accounting. (See below.) Both types of leases would still go on balance sheet.

More than just minimum rent obligation will go on balance sheet, but we’re not yet sure how much more.  Companies will have to capitalize more than just their minimum rent obligation.  They will also have to capitalize some types of contingent rent and some optional renewal periods.  It looks like contingent rent will have to be included as long as it is based on something other than business conditions. For example, rent escalations tied to CPI would have to be included, but rent that is determined as a percent of revenue, such as for a retailer, would not.  (The latter case, though, changes if the threshold of revenue at which that contingent rent kicks in is so low that the contingent rent is deemed to be “disguised base rent”.)

As for optional renewal periods … one of the most contentious aspects of the proposed accounting … the accounting boards have tentatively changed their original proposal and now propose that an optional renewal period would only be capitalized if there is a “significant economic benefit” to exercising the related option. The boards have not, however, provided any guidance on what would constitute “significance” … and it is unclear if they will … and so it is uncertain at this point how significant this “significance test” will be in reducing the number of optional renewal periods to be capitalized. (It seems to me that most options to renew carry a significant economic benefit in the form of avoidance of relocation costs.)

The original proposal would have required capitalizing the optional renewal period when it was “more likely than not” that the renewal would occur.  It was strongly criticized on three counts: capitalizing renewal periods for which companies are not obligated, requiring difficult-to-make forecasts of whether a lease will be renewed, and requiring complex processes to make those forecasts.  Presumably this ”more likely than not” wording has gone away, but conceptual gaps seem to exist, such as whether or not the likelihood of renewal is to be considered before capitalizing a renewal period associated with an option containing a significant economic benefit.

The boards still have work to do in defining when obligations related to optional renewal periods should be included.  They will almost definitely require some optional renewal periods to be capitalized; otherwise companies would be able to structure short leases with options to renew as a way to avoid capitalizing lease periods that will inevitably occur.

The pattern of expense recognition will be high in early years … for at least some leases … and maybe for all leases.  The straight-line pattern of recognizing lease expenses evenly over the course of the lease … as is done today with operating leases … may no longer exist.  The original accounting proposal was to entirely do away with today’s P&L accounting for leases (which, BTW, is the accounting most companies use for their internal budgeting).   The proposal was to replace rent expense with two new types of expenses: amortization of the right-of-use asset and interest on the lease liability.  The latter would be higher in the early years of a lease and lower in the later years, just as is the case in a self-amortizing loan. The resulting high-then-low expense recognition pattern was criticized in many of the comment letters, and so the boards are considering the possibility of defining two types of leases … “finance leases” and (the presently inelegantly named) “other-than-finance-leases”.  The new expense recognition pattern would apply only to the former; the latter would have a straight-line expense recognition pattern similar to today’s expense recognition pattern for leases.  (Whether it would be categorized as rent expense or as asset amortization and liability interest is unclear.)  Debate continues, though, particularly as it is becoming clear to the boards that defining two types of leases creates definitional problems, might require the types of “bright line” rules that are inconsistent with the boards’ goal of creating a principles-based standard, and would likely increase the complexity of compliance processes.

The new accounting will apply to some contracts you do not now think of as “leases”.  A big issue that has caught a lot of people by surprise is that the new accounting necessarily will apply to implicit leases, i.e. those contracts that may not be thought of as being leases but which convey to the buyer the right to control one of the vendor’s assets and specify exactly which asset is used.  An example is a photocopy contract which might be thought of as a service contract but which … because it conveys control over specified assets … would be deemed to contain a lease.

The issue applies to assets much larger than photocopiers, though.  Think buildings.  An example might be a logistics contractor who manages logistics for a customer out of a warehouse that is used solely for that customer.  Such a contract might be deemed to contain a lease, and the customer would have to put, on its balance sheet, a portion of the projected future payments to be made to the logistics contractor.  See my previous post on this topic.

Initial application of the new standard may be only a year away … long before the “Effective Date”.  The boards have not yet specified when the “Effective Date” of the new accounting standard will be.  When they do, there is likely to be much misunderstanding because the “Effective Date” is a misnomer.  Companies will actually have to begin applying the new standard retrospectively to leases a couple years prior to the effective date.

According to the Exposure Draft on Leases, the Effective Date will apply as follows.   A company will have to apply the new standard to its annual financial statement for any fiscal year that begins after the Effective Date.  This means, for example, if the the Effective Date was designated as December 31, 2014 (which would be three years after the anticipated issuance of the standard by the end of this calendar year)  any fiscal year starting after that date would have to use the new accounting in its annual statement.  Let’s say the company’s fiscal year began on February 1, 2015, the annual statement for the year ending January 31, 2016 would be the first time that the company would report using the new standard.

That sounds like a long time from now, but consider this: the standard will require that the company retrospectively apply the standard to any financial results for prior years that it presents for comparison purposes in its FY2016 annual report.  The typical company presents two years of prior results and so would have to recast its FY2015 and FY2014 statements using the new accounting.  The latter fiscal year begins on February 1, 2013 and so the company would first apply the new standard on that date, even though it won’t report using the new standard until three years later.

Continuing this hypothetical (but very possibly real time table), February 1, 2013 is only a little over a year after issuance of the standard, assuming issuance by the end of Calendar Year 2011.  This leaves little time to put in place the processes to collect the information and make the assumptions (such as for optional renewal periods) needed for this retrospective application. While companies will not absolutely have to have these processes in place before the initial application, if they don’t, they risk losing information that will later be required for this retrospective application forcing them to undertake the time-consuming and costly reconstruction of historical data and the determination, to the satisfaction of their auditors, of what assumptions they would have likely made in early time periods about things like optional renewal periods, contingent rents, etc.  Putting processes in place to capture this information prior to the date on which initial application takes place will be a wise choice.

There will be no grandfathering of existing leases.  Leases that are already in place today, as well as those signed between now and the Effective Date, will go on balance sheet on the Effective Date if they are still active.  Considering this, the standard … even though it is not yet set … is for all practical purposes already in effect.  Companies should already be taking the new accounting … at least those aspects that are not under debate … into account in setting strategy and making decisions.  This is something that few corporate real estate execs truly understand yet.

Standard will probably be issued before end of this calendar year. Once the boards issue the new standard, companies will have to shift into high gear to address the strategic and process implications.  Companies should already be mobilizing to do this.  I suspect many are not.  For their sake, let’s hope the  fat lady sings the finale of the “Re-Deliberation Opera” loud enough for them to hear.

Lease accounting update: “more likely than not” is no more February 17, 2011

Posted by Bob Cook in Financial Planning & Analysis, Lease Accounting.
21 comments

FASB/IASB have dropped one of the most controversial parts of their proposed lease accounting.   The Exposure Draft, released in August 2010, had called for lessees with options-to-renew to capitalize lease obligations for renewal periods that were “more likely than not” to occur.   This part of the accounting was attacked on many grounds.  First, it was going to require lessees to undertake a lot of work in making the assumptions as to whether renewals were more likely than not to occur, and many thought the benefits to users of financial statements were not great enough to justify the expense of compliance.  Second, in many cases the assumptions would end up being arbitrary, bringing into question whether capitalizing renewal periods had any value.  Third and perhaps ultimately most important, it seemed to fly in the face of other accounting doctrine.  Until a lessee signs up for a renewal period, regardless as to whether an option-to-renew exists, the renewal period is not an obligation.  It just didn’t seem right to put it on the balance sheet.

I think FASB/IASB made the right choice in eliminating this part of their proposal and had recommended that writers of comment letters to FASB/IASB point out the flaws and problems associated with capitalizing renewal periods.  Many others made similar recommendations, and many of the 700-some comment letters received by FASB/IASB recommended that this aspect of the accounting be eliminated.

The people have been heard!

Before “the people” start celebrating, though, they should understand that there will still be a need to evaluate each and every lease, with an option to renew, to determine whether there is an economic incentive in that option such that renewal of the lease is “reasonably assured” … in which case the renewal period would have to be capitalized … just as is the case under present accounting for capital (or financing) leases. 

This test will be much less onerous, though.  FASB/IASB are going to work on the exact wording, but this “reasonably assured” test has a much higher bar than would have the “more likely than not test” … akin to the difference between 99% and 51%.  Few leases will go over the bar and most won’t even come near it so assumption-making will be much easier, and easier to justify to auditors, than it would have been with “more likely than not”. 

Still, though, lessees will have more to do than they do today.  Under today’s accounting, most companies only need to apply the “reasonably assured” test to a very small group of leases that, due usually to their long length, are classified as capital leases.  Many companies have no such capital leases.  Now, though, companies will have to apply the test to all leases.  The process burden will be much, much less than it would have been with “more likely than not” … but it’s going to be measurably more than it is at present.

Click here for more posts on lease accounting.

2011: Year of the Rabbit …. and Decade of the Corporate Real Estate Exec February 13, 2011

Posted by Bob Cook in Alternative Workplace Strategies, Corporate HQ, Financial Planning & Analysis, Green Initiatives, Lease Accounting, M & A Integration, Profession of Corporate Real Estate.
9 comments

This Thursday ends the 15-day Chinese New Year Celebration.  According to the Chinese Zodiac, we’re entering the “Year of the Rabbit”.   We may also, though, be entering the “Decade of the Corporate Real Estate Exec”, the decade in which corporate real estate execs rise to truly strategic roles in their organizations.

The year 2011 will usher in an era of increased responsibility for corporate real estate professionals.  Events playing out this year will put corporate real estate executives, their staffs, and their advisors front and center.  The spotlight will be hot, but rewarding … for those ready to perform.

Leaving the oughts behind

With a name like that … “the oughts” … we should have known the decade from 2001 through 2010 was going to be tough.  Slashing budgets, laying-off people, constantly explaining why the company still has too much space:  it was not the best of times for corporate real estate folks. 

To be fair, the oughts did have their fun moments:  implementing alternative workplaces, expanding into China and India, building solar-power arrays, planning next-generation data centers.  But while these activities were sometimes high-profile (in the sense of “gee-whiz”, isn’t this cool), for the most part they tended to be tactical activities in service to specific divisions or functions … away from the central concerns of headquarters.  They did, however, help raise the self-image of corporate real estate professionals who no longer are satisfied with a backstage, custodial role.  Most are ready to perform on stage.

The good and the bad

So, if you’re in corporate real estate, how will 2011 differ from the past?

Good News:  You won’t be tasked to slash your budgets; corporate profits are doing just fine and executive management is now focused on growth rather than contraction.   You won’t be consolidating (unless your company buys another company to integrate); you’ve already done your consolidations.  And you won’t have to lay off any more of your staff; thank God, that’s over … or at least it is if you avoid being on the “losing end” of a Merger.

Bad News:  Some of you may lament, though, that some of the things that were fun in the past won’t be on the agenda in 2011:  You won’t be constructing many new buildings; we have enough of those for a while.  You also won’t be building out much space inside your buildings because you probably have built space you’re still not using.  You won’t be flying across oceans looking for new space; globalization is taking a breather while companies wait for worldwide demand to catch up with worldwide capacity.  And you probably won’t be doing a big outsourcing; where outsourcing makes sense, you probably already have.

The shape of 2011 and the decade to come

The Year of the Rabbit, CY2011, and the coming decade will bring a new world shaped by these forces: 

  • cash hoards at leading companies in a “winner-takes-all” economy
  • attractive real estate markets  from an occupier’s perspective, for at least a few more years in most locales and indefinitely in some
  • new advances in “green technologies” and lowering prices due to competition
  • the establishment of a new lease accounting standard
  • strained budgets at all levels of government

The New Agenda

This world will bring those corporate real estate professionals who are ready for the stage closer to the core of their companies’ businesses.  The new corporate real estate agenda for the “Year of the Rabbit” and beyond:

  • Acquisition Integration
  • Balance sheet Management
  • Corporate Citizenship
  • Design & Management of Processes
  • Employee Retention and Recruitment

 

Acquisition Integration.  Most leading companies are sitting on cash hoards and have large borrowing capacity, setting the stage to make the year 2011 record-breaking in terms of M&A activity.  Corporate real estate execs will play key roles in integrating acquired companies, as they have been, but those, savvy enough to grab the opportunity, will engage beyond managing cost-saving consolidations.  They will take a leadership role in managing the “soft art” of cultural integration. Corporate real estate execs have an opportunity to address a vexing problem: most M&A’s are unsuccessful.  Most experts think the obstacle to success is cultural incompatibilities.  By simply extending corporate real estate’s responsibilities from the physical environment to the social environment and thinking of themselves, not as “facility engineers” but, as “social engineers”, corporate real estate execs can … and should … take on the challenge of successfully merging cultures to achieve M&A success.

Balance Sheet Management.  All that cash and borrowing capacity at leading companies are going to make real estate central to discussions about financial structure.  Companies need to decide whether they should continue to retain all that cash (something that stockholders don’t like), pay down debt (something that has probably already been done if the company has a lot of cash), give cash to shareholders via stock buybacks or dividends (something that company managers don’t like because they want to keep money for a “rainy day”) or spend it (something that certainly cannot be done foolishly.)    It turns out that spending cash to buy company facilities bridges these concerns: it keeps wealth in the company in a way that can be turned into cash if needed, earns more than cash-equivalent investments, and can often support business operations better than can leasing property.  Real estate is, thus, destined to become important in discussions about a company’s financial structure, particularly over the next few years while an “occupier’s market” reigns and purchases can be made cheaply.  Also entering the discussion will be the new lease accounting standard that will transform the balance sheets of many companies and bring real estate strategy (own vs lease, lease duration, utilization) even further into discussions about company financial structure.

Corporate Citizenship.  Our governments are broke (to use an imprecise but, I think, meaningful term.)  Corporates will be called upon to pick up the slack … either forcefullly by regulation or voluntarily… and they will have to get serious about social and environmental responsibilities.   Federal and state governments can’t afford tax breaks for energy-savings and environmental-protection so companies will be expected to beef up their sustainability programs.  While technological advances may improve the ROI on energy-saving and environmental-protection investments, companies will be expected to make these investments even where there’s no payback.  As for local governments, they can’t afford redevelopment programs so companies will be expected to participate in urban revitalization projects, even when no subsidies are available.  There may even be a return to the civic-mindedness of the 1960’s when corporations built their headquarters with plazas to serve as centers of their communities.  Corporate real estate professionals will be managing much of this good corporate citizenship.

Design & Management of Processes.  As the role of corporate real estate execs migrates towards the center of the company, execs will find themselves spending less time on implementation and more time designing and managing processes to lead, coordinate and govern the implementers, who will increasingly be outsourced providers.  Acquisition integration, for example, requires processes to plan consolidations, account for them, and track implementation status.  Another example: the new lease accounting will require SOX-compliant processes to record leases in a timely fashion, abstract them accurately, and (if the present proposal holds) make quarterly assumptions about their likely lengths, contingent rents, and service components.  All these processes will have to be integrated with processes of other functions … HR, IT, Finance … intertwining corporate real estate with other key functions and making it integral to how the company works.

Employee Retention and Recruitment.  Despite the fact that unemployment is still stubbornly high, competition for top talent is severe.  As product design, marketing, supply chains, financing, and the art of management, itself, becomes more sophisticated, the winning of the competition for sophisticated talent is becoming more and more important to company success.  If you have the best talent, you can create the best products, the best marketing, the best cost structure, etc. … the things that allow you to easily win the competition for customers.  And what attracts talent?  Money helps, but ultimately, it’s about the work environment.  Here again, corporate real estate execs can play an important role by using their command over the physical work environment to help mold the social work environment that will determine how successful their company is in retaining and recruiting talent.

It is a new year:  “Year of the Rabbit”. 

Will it be a new decade:  “Decade of the Corporate Real Estate Exec”?

Facebook taking Sun headquarters? Schumpeter’s creative destruction at work. January 5, 2011

Posted by Bob Cook in Company Case Studies, Corporate HQ, Financial Planning & Analysis, Silicon Valley.
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2 comments
Economist, 1883 - 1950

Joseph Schumpeter, Economist, 1883 - 1950

The Mercury News reported yesterday that Facebook is close to buying the former Sun Microsystems headquarters in Menlo Park CA for its own.

It’s all part of economist Schumpeter’s “creative destruction”.  With innovation, there are those who rise and those who slide.  Over the last decade, Facebook has risen, Sun has slid.

Sun built its million-square-foot Menlo Park campus during the dot-com boom of the late 1990’s (remember that?), back when its Unix-based servers sizzled and allowed Sun’s boastful advertising slogan: “We’re the dot in dot.com”.   Sun even built a couple more million-square-foot campuses in Silicon Valley and made one its official headquarters address.  The Menlo Park campus, though, was never displaced as home of executive management, and it continued to be the “real” headquarters until “the end”. 

“The end” began when the internet boom busted and, as the IT market moved away from Unix, Sun’s revenues busted even more.  Last year, the remnant of the once-proud company was bought by Oracle for $7.4 billion, a paltry sum given Sun’s much-loftier market capitalization ten years earlier.   Sun’s management is largely gone.   When Oracle closed the purchase, Sun’s last CEO Jonathan Schwartz famously haiku’d: “Financial crisis/Stalled too many customers/CEO no more“.  Oracle whose headquarters campus is down “the 101” about 10 miles, apparently, figures it can do without the old Sun headquarters.

As Sun has slid into the tech horizon, Facebook has risen towards the tech heavens.  Founded only a few years ago, in 2004, with a handful of employees, the company now has about 2,000 workers … still small compared to the nearly 40,000 that Sun had at one time, but other stats are superlative:  Its market cap is estimated to be about $50 billion … a staggering amount for a company that is still privately-held … and it claims to have 500 million users!  It even has a movie made about it.  Facebook’s trajectory is strongly upward, and undoubtedly it feels it will fill the former Sun headquarters, which can probably house at least 3,000 workers, in no time.  It’s earned the right to have everyone under one roof … to have its own campus.

A loser, a winner:  It’s the Schumpeter Way.

Do privately-owned companies need to use the new lease accounting? December 27, 2010

Posted by Bob Cook in Financial Planning & Analysis, Lease Accounting.
5 comments

Would Scrooge & Marley have to use the new lease accounting?

This is a question I am often asked.  It’s a good one.  The accounting clearly applies to publicly-owned companies.  They are regulated by the SEC (in the U.S.) which requires the use of GAAP (i.e. generally accepted accounting principles) of which the new lease accounting will become part.  But, what about non-public companies?

Some private companies may choose to ignore the new lease accounting; in fact, some already ignore GAAP altogether.  A small family business … to the extent it keeps books at all … may choose to use any accounting rules it likes …. or at least as long as the family members agree.  For larger companies, though, particularly those with non-familial owners, accounting needs to be more sophisticated; many, perhaps most, will want to apply the new standard.

The reason: If the company needs to provide financial statements to anyone for any purpose, it probably needs to use GAAP in all its aspects, otherwise the party receiving the financial statements won’t be able to interpret the meaning of the financials.   To be more specific, if a company needs to show financials to a bank to borrow funds or to a customer to prove its ability to perform a contract or to partners to show how well the company is doing, then the company probably needs to apply the new lease accounting standard.

I stick in the word “probably” because there may be some companies that are thought to be so sound financially that they are able to be cavalier about how they prepare their financial statements. Also, some companies in some industries, notably real estate investment, feel that GAAP doesn’t really describe the financials of their business well and they use a modified GAAP.  In those situations, the new lease accounting will probably be ignored.   For any company that uses GAAP, though, they’re going to have to use the new accounting.

Person of the Year….. December 26, 2010

Posted by Bob Cook in Profession of Corporate Real Estate.
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This is the time of year when “Persons of the Year” get announced.  Time has anointed Facebook’s Mark Zuckerberg, Fortune crowned Netflix’s Reed Hastings.   They both are sound choices, both have changed the world.

I’m wondering this:  Might the “Person of the Year” ever be someone involved in corporate real estate? Might a corporate real estate professional ever change the world enough to be worthy?

This is not as crazy a question as you might think.  Thirty years ago, “Time’s Person of the Year” titles didn’t go to CEO’s; they went to politicians, artists, musicians, scientists.  (See note below.)  The idea that a CEO’s like Zuckerberg and Hastings (and Turner, Grove and Bezos before them) would be “Person of the Year” would have been thought, by many, to be ludicrous; CEO’s were still thought to be “robber barons”.  So it’s hard to tell what types of people will be capturing the awards in the future.  Why not a corporate real estate professional?

So, for those mid-career corporate real estate professionals who aspire to become a “Person of the Year”, let me offer three visionary roles that might spear the title.

Work-From-Home Revolutionary.   By most measures, employees love being able to work from home. Work-life balance and a sense of greater productivity are cited as the benefits and a revolution has already begun.  Work-from-homers are, though, still a minority of workers.  Might a leader come along who can push the revolution to what-some-think-is its logical conclusion: where the majority work-from-home?  What kind of leader might this be?  Perhaps it could be a corporate real estate exec of a major company (or his CEO boss) who willfully shuts all offices and gets his company to send everyone home to work.   Or better yet, someone who does this for the federal government (and in so doing balances the federal budget by selling off all the buildings that suddenly become unnecessary).  Or maybe it will be an entrepreneur who comes along and establishes a chain of drop-in offices that allow workers from any company to rent space and technology by the hour in office centers that become as ubiquitous as Starbucks.   Some have called the concept “Cloud Officing”.  Or maybe someone who takes Starbucks … which already offers a small form of this… but expands and augments the Starbuck’s mission to create the drop-in centers that truly transform how and where and the majority of people work.   Would not such a person be worthy of being anointed “Person of the Year”?  Isn’t how people go about working at least as important as how they watch movies?

Planet Saver

Or, how about someone who discovers some incredibly simple, inexpensive way to reduce the fossil-fuel consumption of buildings.  What might that innovation look like?   It’s probably not something like use of solar energy which is a technology that is sure to continue to advance but not in any revolutionary way; radical change is needed to be crowned “Person of the Year”.  So, think more radically.  Imagine a garage-tinkering facilities manager who finds a simple way to make electricity from the kinetic energy of workers walking around the office.   That’d, for sure, capture the title.   Get tinkering.

Civic Builder

And I have one last suggestion … maybe not quite so “out there” … that could capture the “Person of the Year” title.  Imagine a corporate real estate exec at a fast-growing company that suddenly needs large amounts of office space in major cities … somewhat similar to the situation tech companies like Cisco, HP and Oracle found themselves in at the height of the dot-com boom.  Now think about how a confident corporate real estate executive could use this building program to change the face of the cities where he’s building by constructing buildings with important public spaces, buildings that positively impact the civic life of the city.  It has been several decades since we saw companies building such “people places” as New York’s Citicorp Plaza,  Chicago’s First National Bank Plaza (now, JP Morgan Chase Plaza), and San Francisco’s Crocker Center.  Those tower-and-plaza forms might not be what would make sense today, but I’m sure that there’s some way to make a positive civic impact.

Target: 2020

Achieving great things in corporate real estate takes time, though, so set your sight on getting the “Person of the Year” award, not next year, but maybe a decade from now.  The year 2020 is a good round-number target.   Who out there is up to the challenge?

A Note on Time’s Person of the Year

The first Time “Man of the Year” (as it was originally called) was Charles Lindberg in 1927, and then the next two years the title went to business persons: Walter Chrysler of Chrysler in 1928 and Owen Young of RCA  in 1929.  Then, though, between 1930 and 1990, not a single business person received the title … a sixty-year drought.  Since then, the title has gone to Ted Turner of Turner Broadcasting (1991), Andy Grove of Intel (1997), Jeffrey Bezos of Amazon (1999) and now Mark Zuckerberg (2010).  Of eighty-one titles, only six have gone to business persons, although there have been four business persons named in the last two decades.

May the Christmas spirit be with you … and your company December 19, 2010

Posted by Bob Cook in Corporate HQ.
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My first experience with corporate real estate was when I was a child growing up in Pittsburgh.  Of course, I didn’t at the time think of it as having to do with corporate real estate, but in retrospect, I realize it was.

Every Christmas season my parents would take me downtown to see the Christmas decorations. My favorite displays were the animated scenes of Santa’s workshop in the windows at Horne’s Department Store.   I also, though, loved seeing decorations at all the big company headquarters.  I remember vividly a large Christmas tree in the big glass lobby of the Alcoa Building and a giant Christmas wreath over the gothic entrance of the Gulf Building.

I don’t get back to Pittsburgh at Christmas anymore so I don’t know if the Alcoa tree and the Gulf wreath are still traditions kept there, but I certainly hope so (… even though, I know, Gulf’s HQ isn’t in Pittsburgh anymore).  Those holiday displays were a way for the companies to give a present to the community each Christmas season.  It couldn’t have cost much, and it brought much wonderment.

I fear, though, that many, maybe most, companies have lost the Christmas spirit.  Few, today, contribute to holiday festiveness the way companies did in the past.   There are many reasons for this: multiculturalism, shareholder activism, bottom-line focus, suburbanization, globalization.   In this environment, it takes courage for a corporate real estate executive or any type of executive to authorize Christmas displays.   Those who do should be applauded.

I take heart in knowing that, in Pittsburgh, the Christmas spirit still seems to be alive.  This year, the community celebrated the 50th installment of Light-Up Night which kicks off the holiday season in “the ‘burgh”.  It’s now a two-day festival.  Downtown buildings keep all their lights on all night long, and yes, corporations participate: a 60-foot tree rises lit on PPG Plaza and the Pittsbugh Creche (a religious display, no less) sits prominently on U.S. Steel Plaza.

I hope the Christmas spirit is alive in your community …. and, if you have some authority, you do what you can to keep it alive in your company.   May the spirit be with you and yours.

We’ve Got Pop-Up Stores; How about Pop-Up HQ’s? December 15, 2010

Posted by Bob Cook in Corporate HQ, Financial Planning & Analysis.
6 comments

T’is the season for pop-up’s. 

They’re everywhere.  Retailers have figured it out.  If you do most of your business at only certain times of the year … Christmas, Back-to-School, Summer Vacation … then why rent space all the other times?  There’s a lesson here for corporate headquarters.

The Pop Up Phenomenon

In early fall, Halloween stores appeared.   The chain of “Spirit Halloween” stores, for example, opened nearly 900 pop-up’s around Labor Day and kept them open through Halloween.   Then in November, Christmas gift stores began popping up.  Many examples here, but perhaps the most notable: Toys-R-Us opened over 600 “Express” stores this season and resurrected the “FAO Schwartz” name in the form of 10 pop-up’s in tony locations to serve the top (or you might say “over-the-top”) of the toy-buying  market.

Trendwatching.com takes credit for coining the term “pop up store” back in 2004.  As the examples on its website shows, the phenomenon isn’t just for Halloween and Christmas.  Pop-up’s pop up year-round.   They sell the gamut of merchandise … from designer clothes to gourmet food to cat snacks … and they’re run by all types of retailers … from small-time, one-timers like the Meow Mix Company … to big-time, part-timers like MTV … to big-time, full-timers like Target and JC Penny.  Pop up’s aren’t just for mom-and-pop’s anymore.

And they might not just be for retailers, anymore, either.

Entropy and the Corporate Headquarters

It used to be that all the folks “at headquarters” were, in fact, physically, at headquarters.   Not anymore.  In this day of specialization, getting the right person for a high-level position often requires ignoring geography.  If the best CFO-candidate is in Houston and he won’t move to headquarters in Atlanta, then give him a cell phone and VPN-access, and he’s good to go.  The same goes for middle-level managers and individual contributors where the competition for talent is strong.  As for the lower-end of the corporate hierarchy, those headquarters functions are more-and-more outsourced, off-shored, or near-shored.   When an employee calls “headquarters” to find out why his travel expense hasn’t been approved or what his HR benefits are or how he should connect his computer to the company’s main servers, those calls rarely go to anyplace one might think of as headquarters.   In fact, in the modern corporation, it’s often difficult to identify where headquarters is.  There’s no “there” there anymore.  “Headquarters” no longer has a physical connotation.

Where’s the center?

Yet, many think there is a need for some sort of center. … a place that symbolizes and embodies the company’s values, it’s soul.   If we’ve learned anything about corporate management over the last few decades, it’s that culture is important.  Read Good to Great.

For many companies, the center is now the company’s intranet.   That can work pretty well.  If you’re an employee, the homepage lets you know what’s happening around the company.  Video-on-demand lets you actually see the CEO talk about things he thinks are important.  And the use of social media … including that old-fashioned thing called “email” … allows employees at all levels engage in “water cooler” conversation, virtually.   This leads some to observe that the importance of physical place is dead.  But is it?

Different companies with different cultures answer this differently.   For some, a traditional corporate headquarters with “all hands on deck” might make sense.  For others, a totally virtual headquarters might be better.  For most, though, something in-between works.  But there’s a lot of terrain between the two extremes, a lot of room for different headquarters models and hybrids.

Why not a  Pop-UP HQ?

Consider a company that has headquarters personnel widely distributed  … perhaps globally.   It might have an address where some of the executive management and headquarters staff have offices, but it does not have anything like the traditional headquarters with most headquarters folks under one roof.  Company management feels a need for more face-to-face interaction across the headquarters staff.  Solution:  No need to lease a big corporate headquarters building; instead, have a pop-up headquarters a few times per year.

Now, many companies are already doing something similar.  Many have an “annual meeting” that takes place in a location like Las Vegas, where there’s an emphasis on building relationships via having fun.   It’s usually two or three days with a few convocations, maybe some training sessions, and a lot of golf and partying.

I’m talking, though, about something else.   I’m talking about creating a place, albeit temporary, that functions like a headquarters.  You don’t party at headquarters, and you wouldn’t at a Pop-Up HQ.  What happens at the Pop-Up HQ wouldn’t “stay there”.  What happens there … the sharing of stories, ambitions, insights, ideas … would build a culture that attendees would take back with them.

And the time at the Pop-Up HQ would not be structured around big presentations, training sessions, and the like.  That stuff can happen better on the intranet.  That’s not what happens at a headquarters.  Instead, attendees would meet with one another in groups of their own choosing.  Need to talk to the CIO?  This is your chance.  Need to know the real skinny on how a project is doing overseas, talk to the director in charge.   Need an impromptu meeting because of an issue that arose during a planning session earllier in the day, now’s the time to get all the folks together.

And the Pop-Up HQ would have to last a lot longer than a few days … and be more frequent than once-per-year.    You’d need at least a week; two would be better.  People need time to meet and then set up meetings based on the outcomes of those meetings.  As for frequency, quarterly feels about right.

Cost?  Certainly no more than renting and maintaining a headquarters building to house people who are rarely there.  Where?  Hotels, convention centers, and … if the phenomenon took root … empty (perhaps former traditional headquarters) office buildings that have been repurposed to serve as Pop-Up HQ’s.

Farfetched?  Maybe.   But two decades ago, the idea of loads of headquarters workers not being at headquarters would have seemed farfetched, too.

Few Comments from Lessees on New Lease Accounting as Comment Deadline Approaches December 13, 2010

Posted by Bob Cook in Financial Planning & Analysis, Lease Accounting.
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In August of this year, FASB and IASB jointly issued an “Exposure Draft on Leases”, outlining proposed new lease accounting.  This proposed accounting differs significantly from present accounting, most notably by putting all leases on balance sheets.  The new accounting will affect both lessees and lessors.

The proposed accounting is not without controversy.  While there is no strong, informed argument against putting leases on the balance sheet, there are such arguments against some of the details of the proposed accounting … for example, the requirement to capitalize “likely” lease payments, taking into account options to renew, as opposed to just capitalizing contractual obligations.  This provision, in particular, has elicited much outrage at real estate industry forums.

The accounting boards are receiving comments on the proposed accounting until December 15, just a couple days from now.  Comment letters received by the boards are posted on their websites.  So far, a little over 100 letters have been posted.

The surprising thing: very few of the letters come from big-name companies with large lease portfolios.    In fact, by my count, only three of the Fortune 500 companies have commented thus far; only one is in the top 400 and none are retailers, whose balance sheets will be hit significantly by the new accounting.

Now, it’s possible that more companies have submitted and the boards just haven’t posted them yet, but still … three letters from Fortune 500 companies is an incredibly small number to have been posted at this late date, given the controversy surrounding the proposal.  While a slew of comment letters might be forthcoming over the next few days, one would think that companies would have wanted to get their letters in early so other companies could follow their lead, by reiterating their comments.

It appears that the corporate real estate community, which has a strong stake in the outcome of the new accounting, has not been very successful in getting companies to raise the points of concern that have been the subject of industry forums.   Was it lack of true concern?  Inability to influence within the corporation?  Unfamiliar terrain?

To see my previous posts on the new accounting, including my recommendations for comment letters, click here.

Implicit Leases: The hidden bombshell in FASB’s new lease accounting December 5, 2010

Posted by Bob Cook in Financial Planning & Analysis, Lease Accounting.
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As we approach the December 15th deadline for commenting on FASB’s and IASB’s “Exposure Draft on Leases”, I thought I’d point out a far-reaching implication of the new lease accounting … an implication that has gotten surprisingly little attention.  It’s this: the new standard applies to not just explicit leases, but also to implicit leases.

Now it should be obvious that just because a contract explicitly says “Lease” in its title, does not mean that it is a lease … for any purpose, let alone accounting.  Also, conversely, a contract that does not say “Lease” in its title is not necessarily not a lease.  Under lease accounting, if a contract is or contains an implicit lease for accounting purposes, it’d have to be accounted for, in whole or in part, as a lease.

What-you-don’t-think-is-a-lease but which is a lease in terms of accounting, may surprise you.  The accounting definition of a lease does not conform to any layman’s definition or, for that matter, to any legal definition.  For  example: some types of licenses that give a company the right to occupy space, perhaps as part of a larger contract, are likely to be deemed to be leases for accounting and have to be accounted for as such.   In addition, the new accounting will also apply to service contracts involving equipment, such as photocopy machines.

The implicit-lease issue goes, though, far beyond licenses and equipment-based service contracts.  It will apply to some subcontracts and outsourcing arrangements … contracts that the contracting parties undoubtedly do not now think of as leases.

How’s that?

Appendix B of the Exposure Draft provides the proposed accounting definition of a lease.  It says, in essence, that each and every contract a company signs needs to be evaluated to see if it is or contains a lease.  If the following two characteristics are present, part or all of the contract must be accounted for as a lease:

(a)    the fulfilment of the contract depends on providing a specified asset or assets and

(b)   the contract conveys the right to control the use of a specified asset for an agreed period of time.

The document goes on to provide guidance in addressing these two tests, and you should read this guidance to understand the nuances.  Regarding these two tests as it relates to buildings, (a) a building would be deemed to be specified if the supplier was not able to relocate production to another facility without the customer’s approval, and (b) the building would be deemed to be under the control of the customer if the customer got all but an insignificant amount of the benefit from its use.  While contracts that call for payment on a unit-price basis would probably not be deemed leases, there will still be some types of sub-contracts and outsourcings that will be deemed to have implicit leases embedded in them. 

Consider a contract where Company A outsources logistics to Company B for a period of time and agrees to pay a certain amount each month for the service.  If Company A gets to say in which of Company B’s facilities this work is done and if the work Company B does in that facility is almost all to service Company A, then it is very possible that a portion of that contact will be deemed to be an implicit lease.  The obligation related to that portion would have to be capitalized and put on Company A’s balance sheet; Company B would account for that portion of the contract as a sublease.

This is going to take a lot of companies by surprise, and has an ironic twist.  One of the motivations for many companies who have outsourced work previously done in-house has been the ability to get assets (and related liabilities) off their balances sheets.  Well… surprise, surprise!  Those assets and liabilities may be coming back as a result of the new accounting.

The implicit-lease issue could even hit parts-supply contracts where conditions (a) and (b), above, exist and contract pricing is on a cost-plus-profit basis.  It also may hit energy contracts where a third party installs energy-saving or power-generating equipment, such as solar panels, on a customer’s site and then sells the power to the user.  This could have a big effect on the business models of such third-party suppliers of energy.

In truth, the need to evaluate whether a contract contains an implicit lease is not new; it already is an accounting principle.  Heretofore, though, unless an implicit lease met the conditions that made it a capital lease (which would then have to be put on the balance sheet), the identification of a contract as being or containing an implicit lease was non-material.  This is because operating leases and service contracts have been accounted for similarly … both off-balance sheet.   The “implicit lease test”, therefore, tended not to be applied rigorously.  Now with the new lease accounting putting leases on balance sheet, though, the test as to whether a contract is or contains a lease is far from immaterial.

The implication of applying the new lease accounting standard to implicit leases could be vast.  In theory, every contact signed by a company will have to undergo a “lease test”, just like today every lease needs to undergo a “capital lease test”.  Think of the process implications.  And beyond that, think about how your company might have to re-think strategies surrounding outsourcing and supply-chain management.  This is yet another reason that the new lease accounting has implications far beyond what most people think.

Lease accounting isn’t just for real estate, anymore … and it’s not even just for the-contracts-you-thought-were-leases, anymore.

Click here for more posts on the new lease accounting.