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Supply Chain Why you might be buying industrial real estate soon By Christopher Steele, president, CWS Consulting Group LLC Some time back, I wrote a column describing an archaic accounting rule called FAS 13. This little rule – first hitting the books in the mid 1970s – set up the procedures by which accountants all over the United States determine whether a lease should be treated as an expense or as a capital commitment on the company’s financial statements. If it’s an expense, the lease doesn’t imply ownership and looks like the normal cost of doing business. A capital commitment looks like a long-term liability, however. It looks like the company owns the asset. FAS 13 and operating vs. capital leases The FAS 13 tests were set up to establish the lessee’s true liability. These are: Does ownership of the asset/facility transfer to the lessee at any point? At the end of the lease, is there an option to purchase the facility at a below-market price? Does the lease period account for over three-quarters of the useful life of the facility? Does the total net present value of the minimum rent payments account for 90 percent or more of the facility’s fair market value? These tests were somewhat arbitrary and a little difficult to follow, but they did provide a framework for reporting what was truly “owned” by the company and what was only rented. Ownership was determined by the control, value, and financial life of the asset. The volatility in the financial markets has pushed the Federal Accounting Standards Board (FASB) into improving transparency on corporations’ long-term financial commitments across the board. In particular, they want to reduce the amount of “off balance-sheet transactions” that still represent long-term financial commitments. This impacts leases, because though leases are not true fee simple ownership arrangements, they do reflect long-term financial commitments for the company. While leases are not exclusive to real estate (equipment leases will also be affected by the rules change), they do make up most of the contracts that will be affected by the rules change. And, while the rules are not fully complete and won’t take full effect until 2011 or 2012, few corporate real estate executives have yet grasped that, if the rules go into effect as contemplated, all of their leases will eventually show up on corporate balance sheets as capital leases. Or, to put it another way, their financial reports will state that they own all of their real estate, whether held by fee simple or by lease. Implications This will likely change corporate behaviors dramatically with regard to operating real estate. Each transaction will have to be reported on the balance sheet, and hence each will be due an additional level or two of due diligence. First - companies will likely move quicker when they determine that they no longer require a leased facility. A quick write-down, lease termination, or sublease will ensure that the commitment is removed from the corporate balance sheet and improve overall financial performance. Second – since the two structures (owning and leasing) will look the same on the books – companies will take a more comprehensive look at their individual facilities to determine which strategy should be used for operational and strategic drivers, rather than for accounting reasons. For example, this could cause a preference for ownership in select cases, especially those with long-term (10-years plus) requirements. Third – and most hopefully – companies will more actively manage their real estate portfolios. By understanding their short-, medium- and long-term real estate requirements, companies will work to develop strategic real estate plans that accommodate their occupancy and operational needs now, and which can adjust to meet a variety of eventualities. Having real estate obligations – whether leased or owned – that overhang an operational requirement will not only be inefficient, but will also adversely impact GAAP reporting. All in all, these new rules will not only drive more transparency in any publicly traded company, but could also result in a more thoughtful approach to managing real estate. Next month we’ll go back to our regularly scheduled topic and look at logistics development trends in EMEA (Europe, Middle East, and Africa).	In This Issue Up Front News, Trends & Analysis News Trade Tools: Missing money Capitol Watch: Focus on job creation Supply Chain Chris Steele: Why you might be buying industrial real estate soon Compliance Corner: Use the Web for denied party lists Tech Trends: From open source to terminal visibility Product Review: Trucking drayage and chassis management software Commentary David Bennett: Real signs of trouble Gateway Glance New England Southern California The Port Community Bumpy Ride: Rebuilding PNW containerized exports Southwest Intermodal: Can intermodal incentives show the way? The Shipping Environment: Engaging in the community, slow steaming, and new green products Oceans are making waves Casualties The Big Texas spill leads off this month’s rundown Final Say Top 25 TIGER projects
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