Good portfolio management dictates the continuous review of a company’s real estate uses. Are we being efficient and cost effective? How is our use of real estate adding value to our company? What real estate is core to our successful long-term operations and what is not? The answers to these types of queries should help companies decide when the ownership of real estate is appropriate for them. Most corporate real estate departments are geared to making sure that the company is in the right places to do business, that associated bills are being paid, and that facilities are running as efficiently as possible. So, most corporate focus rests on real estate that is essential and actively used, with attention then being paid, if at all, to idle or non-essential real estate.
In today’s corporate compliance and accountability climate, the Sarbanes-Oxley Act of 2002 (SOX) has created an almost perfect storm, if you will, of corporate accountability. This covers accounting accurately and fully on not only financial activities and operations, but also better disclosure of corporate risk elements, including environmental liabilities. SOX incorporates compliance with Generally Accepted Accounting Principals (GAAP) and requires keeping up to date with all the new rulings and FASB interpretations. Corporations have spent the years following the enactment of SOX putting systems in place, both internally and through vendors, to ensure their compliance. The focus has now shifted from gaining internal control of reporting to making sure vendor relationships are providing value to these efforts. As real estate service providers, brokers and other management and consulting professionals are in an excellent position to demonstrate these value-add capabilities.
In this era where one cannot afford to let a sleeping dog lie, companies must provide current information on the real estate they own, its market-based value, and on any associated risks and liabilities of ownership. SOX dictates a robust, current conditions reporting environment underpinned with certification of company financial statements by CEOs and CFOs. Many companies are now requiring accountability of financial reporting through sub-certification by business units for their financial statements. This increased reach in corporate accountability is also combined with new environmental compliance obligations. SOX has squarely focused reporting on complete and timely information flow. FASB 47 (December 2005) - Accounting for Conditional Asset Retirement Obligations, states that companies must now identify and report pollution clean-up liabilities even if they are not under any regulatory enforcement. This combined level of reporting and compliance is changing the way companies are viewing, in particular, the real estate they own directly.
Real estate service providers are involved in helping corporate clients meet their reporting and compliance obligations for the real estate they occupy in numerous ways. Through Section 404 of SOX and the use of Type 2 SAS 70 reports, companies are gaining confidence that the information they receive regarding their use of real estate is sufficient to meet their own SOX compliance obligations. Leased real estate reporting is generally captured through this system. For owned real estate, however, the process is more involved. When a company owns real estate, it must also ascertain and report on liabilities associated with its ownership, whether the asset is actively used or not. Corporations must be prepared to address a myriad of issues, including:
- Accurate forecasting of costs associated with ownership.
- Impact of current or potential environmental issues.
- Capital obligations, including debt and equity structures and interest rate risk.
- Valuation issues including book vs. market value.
Addressing these issues is meant to provide as complete a view as possible of the economic value of the ownership position. As mentioned previously, Fin 47 requires the reporting of clean-up liabilities and reporting of these asset retirement obligations (AROs) is to be at fair market value. In addition, FAS-144, Accounting for the Impairment or Disposal of Long-Lived Assets, goes further in stating that a company must simultaneously account for the AROs as a liability and establish an asset reserve of equal amount. This obligation calls for a recoverability test to determine if asset is capable of producing enough cash to pay for the liability. Idle assets are most likely to fail this test, this triggering a write-down requirement.
It is the combination of these types of requirements that dictate the need for clear ownership objectives by companies for the real estate they own and the vigorous assessment of the continued ownership of real estate that does not appear to be economically viable. This makes it all the more important for companies to gain a complete understanding of how they use real estate and when it makes sense to own vs. lease. There will always be sound reasons a company decides to own real estate directly. If the assets are monitored and reported on in an accurate and timely manner, inefficiencies and potential associated liabilities are minimized. Systems can be used to manage the financial uncertainty of any environmental risk. However, non-essential assets become much more likely to present unacceptable holding obligations, especially if there are economically unfeasible liabilities associated with the asset. Redeployed capital from disposal of these types of non-core assets becomes even more valuable in this environment as it also reduces additional risk and potential liability, thus enhancing overall corporate value.
This whitepaper was written by Linda Tresslar, managing director, consulting services at Grubb & Ellis Co. (www.grubb-ellis.com) and reprinted with permission from the Northbrook, IL-based full-service commercial real estate organization.