In a letter delivered to The Trump Organization yesterday, a US government agency acting as landlord to the President’s luxury hotel in Washington DC has determined the President’s hotel is in compliance with its lease.
The GSA lease, discussed earlier here at CRE Blog, has a 60-year term on the renovated former US Post Office Pavilion property that the President, while in real-estate developer mode, converted to the luxury Trump International Hotel D.C.
The GSA, whose purpose is to manage half a trillion dollars worth of federal property in a portfolio of over 8,300 owned and leased buildings, sent the letter in response to unique questions arising from the non-divestment of President Trump from his portfolio of properties. GSA is the owner of the building in question and was called upon to review the structure of the lease for compliance.
The letter is fascinating in that it provides a rare view into an operating structure of a Trump property, plus a snapshot of some of the Trump / Trump family’s real estate empire’s various legal structures. It also references that the hotel operations group undertook changes to Section II of its internal operating agreement in order, one assumes, to achieve compliance.
Getting Paid? No, says GSA.
CBS Marketwatch reports that the changes and structure as expressed in the letter makes it so that distributions sourced from the hotel will not make it to the pocket of the President; such funds instead will remain within the operating LLC rather than going to his ownership vehicle.
For some entities’ fiscal years beginning after December 15, 2018, we can expect to see the appearance of new property lease standards as enforced by the Financial Accounting Standards Board. Commercial real estate industry lease agreements will be subject to a new accounting standard intended to force the recognition of leases that run longer than twelve months as assets or liabilities on the books.
That’s not to say the new standards exempt leases that run shorter than one year — lessees may choose to not record an asset or liability for a lease a) whose term runs less than twelve months and b) that includes no purchase option that the lessee is reasonably likely to activate.
Minimizing the impact
The landlord side of the negotiation table is likely to be faced with pressure to reduce the lease term so as to retain the flexibility afforded by lease accounting under the old standards. Prior to the new standards, leases were not commonly characterized as assets or liabilities and as such could be arranged relative to an owner’s bottom line with much more latitude than is offered today.
A major segment of the property leasing world impacted by the standards is tenants at the crossroads considering wether to rent or buy. As Howard Barash of CohnReznick writes in National Real Estate Investor:
Preparing for, and complying with, the new leasing standard is not all bad news. In fact, smart businesses should treat the implementation of the new standard as an opportunity to re-evaluate, and then optimize, their leasing strategies. Companies should closely examine their current leasing contracts. They should also revisit their lease vs. buy decision criteria in light of the standard to determine which option makes the most sense for their business.
The implementation deadline for the new FASB lease standard is approaching and will be here before we know it. It will impact most businesses well beyond an accounting exercise. As such, now is the time for your business to examine its leasing process and gain input from your key business leaders.
Got questions abut the recent big changes in lease accounting standards? Mark the date: March 29, 2016, the Financial Accounting Standards Board (FASB) will hostIN FOCUS: FASB Accounting Standards Update on Leases, a live webcast taking place from 1:00 to 2:00 p.m. EDT. The webcast will feature FASB Members Marc Siegel and Daryl Buck discussing the update in lease accounting standards with FASB staff, and answering questions submitted by viewers. Live broadcast viewers will be eligible for up to 1 hour of CPE credit. For more information or to register for the free event, click here.
Further information about the ASU—including a FASB In Focus overview, a FASB: Understanding Costs and Benefits document, and a video titled Why a New Leases Standard? —is available at www.fasb.org.
Brokers and landlord reps use of the escalation clause in a commercial space lease is a common one. These clauses provide for increases in rent over a specified period of time. Often, these increases are determined not by actual increases in the landlord’s operating costs, but are instead keyed to an index, such as the consumer price index (CPI) or the London Interbank Offered Rate (LIBOR).
Longer-term office leases so often involve the landlord’s lender that negotiations over lease provisions can seem to be between a tenant and lender rather than tenant and landlord. When a lender is in a position of underwriting the cash flow of a building, it’s that lender’s job to scrutinize closely the creditworthiness of a prospective tenant.
And therein lies the rub these days. The capacity of lenders to scrutinize creditworthiness has been called into very stark question thanks to a continuing series of scandals and financial meltdowns, the latest of which probably directly affects the lease on your table today. The LIBOR number — an interest rate that drives the rent escalation clause math in untold numbers of commercial space leases — looks like it is, was, and continues to be, in a word, rigged by banks. Banks, under investigation for engaging in book-cooking to cover their derivatives traders and to pretend to the wider market that the cost of money is lower than they actually pay, have distorted the LIBOR number to the point that holders of financial transactions that are keyed to it are hurriedly reviewing their portfolios in a hunt for lost money. And there’s plenty to find — LIBOR lives in the beating hearts of $350 trillion worth of contracts according to the Financial Times.
Going Up? No, actually
One argument about LIBOR in commercial space leases is that the bank scandals benefited tenants at the direct expense of landlords using escalation clauses tied to LIBOR. If, as allegations claim, starting in 2007, large banks began underreporting their costs of borrowing in order to stave off a rising sense of panic in the credit markets, that means that during those quarters, commercial landlords using LIBOR indexing in their escalation clauses were left holding the bag on rent — charging tenants less than they would have been due under the lease terms had LIBOR not been corrupted for the purposes of the banks’ charade.
One of the truisms in this business for both prospective tenants and landlords is to protect yourself — to secure your own representation at the deal table or otherwise run the risk of having your interests overlooked. But when our pinstriped friends the bankers are at the same table, offering both sides index numbers that amount to broken instruments designed to cover some derivative trader’s rear end instead of either the tenant or the landlord’s — how do you protect from that?
It’s not possible to patrol the commercial RE beat online without finding Coy Davidson. A Senior VP at Colliers with twenty years in the business, Coy writes The Tenant Advisor, one of the better blogs dedicated to commercial property markets with a focus on corporate real estate and tenant representation and office solutions.
His recent post is titled Know Your Numbers. And when he says “know”, he’s not kidding. His advice to agents is to embrace the math in the financial analysis spreadsheets by learning it away from spreadsheets — old-school — to the benefit of everybody at the table. He writes:
Today, computer software makes it easy to crunch the numbers and produce impressive looking reports. However, I am often surprised at how many agents even with a few years experience lack the financial expertise to speak the CFO’s language and effectively advise their clients.
I learned the economics of a lease transaction with a financial calculator and a legal pad and I think young brokers should do the same. If you are going to lay that impressive spreadsheet on your client’s desk, you should be able to explain what the numbers mean and more importantly “why they are what they are.”
Mr. Davidson’s not wrong. In fact, in a financial era marked by disasters rooted in financial opacity, “innovation” and outright fudging as could only be enabled by Excel and its like, any call to get back to the math underpinnings in finance is a refreshing voice of sanity.
The good news about spreadsheets is they simplify presentation and provide incredible flexibility and customizability. The bad news about spreadsheets is…they simplify presentation and provide incredible flexibility and customizability. What’s good for presentation is often no good for content. It’s too easy to copy and paste blocks of cells from one deal template into another without ever considering the applicability of such terms to the specific client or to the investor. The ends might not even come close to justifying the means, but whether the user chooses a method either out of a shaky grasp on the fundamental math, or worse, out of a single-minded focus on the bottom line, the spreadsheet dutifully represents and enables. Which is both a shame and a warning to not do all your work in a spreadsheet.
Opening up, as Coy suggests, a legal pad and a financial calculator before opening a spreadsheet brings real understanding to dealmaking by teaching principles of valuation, and more importantly, teaching how to arrive at valuation principles – not just taking them as a given as inherited from cells D26-36.
Time to indulge in a little blatant localism. Just a short trip along the river from NAR’s downtown Chicago headquarters downtown is the Merchandise Mart, that massive 1930 monument to merchandising and architecture of the early 20th century. Its four million square feet see 20,000 visitors and tenants passing through its art deco doors every day, most in the retail and wholesale business. But a recent 15-year, 600,000 sq. ft. deal involving a technology giant creates a lot of upheaval, changing the mix significantly while it projects the Mart well into the 21st century.
Motorola Mobility’s Reverse Migration
In the largest single employer influx to Chicago in decades, cellphone and communications technology maker Motorola Mobility announced a move of their operation with its 3,000 employees away from suburban Libertyville to the Mart. A rare reverse of the decades-long commercial trend emptying city centers in favor of suburban locales, the move came soon after the company had been acquired in a $12 billion deal by internet search engine and applications giant Google. The moving and build-out costs alone are $300 million, as the merged company’s product design and hardware engineers. More or less, this means Motorola’s efforts in the rapidly-changing mobile device market will be footed in downtown Chicago, suggesting that 3,000 jobs could be just the ground floor number.
Make Room, Make Room
When a single-building tenant needs 600,000 square feet, chances are that means changes for existing tenants. No exception in this deal, as debt collection firm Harris & Harris can attest. The deal pushed an early end to their lease in the Mart, occupying 68,000 sq. ft. of office space, said Harris & Harris CEO Arnie Harris. The firm received a “substantial” sum to terminate the lease early according to Harris, and the company quickly found new digs about one mile south at 111 W. Jackson, a 24-story tower brought out of foreclosure in March of last year.
Downtown Chicago Picking Up Steam
Downtown Chicago vacancy overall fell to 14.8 percent at midyear, down from 15.9 percent a year earlier, according to CBRE Inc. Like most urban centers in the US, downtown remains a tenants’ market, but some feel this is changing as suggested by the Mart upheaval. The 88.5% occupied Mart itself is expected by some to be in the news again soon as the subject of another blockbuster deal: its own sale.
“If you were going to decide that you wanted to sell the building, doing it with some big, positive momentum is the time to do it,” said Bruce Miller, a managing director at Chicago-based real estate firm Jones Lang LaSalle Inc., who sells office buildings.
The Merchandise Mart was 88.5 percent occupied at the end of the second quarter, according to a Vornado quarterly report.
Vornado almost sold the building two years ago, and lately has been shedding properties to streamline its portfolio. In September 2010, Vornado confirmed it wanted to unload the property as part of a sale of its Merchandise Mart Properties Inc. division. But a $1.25 billion deal for the business fell apart.
Vornado in January sold the property next to the Mart, the former Apparel Center at 350 N. Orleans St., to San Francisco-based private real estate company Shorenstein Properties LLC for $228 million. But the company has said it plans to hold onto the Mart for the time being.
Adaptive re-use, technology, commercial property and jobs. Thus is a 21st century economy made.
As we’ve written about before, recent proposed changes to accounting standards would have enormous impact on commercial real estate leases. NAR has been on the forefront of calls to ensure proposals do not adversely impact our industry.
What might not be clear is that these changes impact not only commercial real estate, but all commercial leasing in general. That means that our industry is one of a set of industries that do business using leases and for whom these accounting standards changes would bring major changes to business and markets.
While reading up on the impacts to commercial real estate first and foremost will get you caught up on the impacts to our industry, you don’t need to stop there. The Federal Accounting Standards Board, FASB, the body who is undertaking the proposal to make the accounting changes, has made public over 800 comment letters from around the world on the matter of lease accounting standards changes.
The renting of everything from trucks to planes to equipment, the markets for life insurance, the use of service contracts are all potentially touched by these proposed standards changes. With over 800 letters to choose from, FASB has done us a valuable service in collecting in one spot so many voices from the business communities that depend on leases and their accounting rules. Reading through the comment letters shows in how many ways these accounting rules changes, if adopted, can wreak havoc on a wide set of industries and produce negative consequences far beyond the ills the changes are meant to address.
From the raw land, development and investment side of things: CCIM Institute’s newest podcast is a discussion with Philip “Fred” Himovitz, CCIM, all about the ins and outs of the ground lease. The advantages and considerations of ground leases over fee simple ownership are explored, as well as seniority, management, financing and tenant issues. Even though the podcast is under nine minutes, a solid summation of ground lease structures and purposes is covered.
Popular in the development of raw land, ground leases are also instrumental in the development market for alternative energy. In some states, temporary interest in land is obtained by wind farm builders using a ground lease. This frees up the builder from taking title or committing the planned use to an indefinite term, which is instrumental in attracting investment in these early days of such important technologies.
Current market conditions have led to ground leases being more widely accepted and understood. They provide opportunities to reduce capital requirements and allow ideal platforms for joint ventures. These deals are usually of a long term and let developers and landowners partner in the development, creating the opportunity to shape a deal’s risk profile and more readily allow securitization to spread risk – and returns – around.
Yesterday’s presentation from Bob McComb on getting your start in commercial real estate had plenty of great ideas, but one that stuck out to me this morning was about commercial leases.
Bob noted that a major barrier to entry to commercial dealmaking is the dreaded lease form. The legalese on a boilerplate form can make your eyes cross, and customizations from companies or owners or tenant reps only make it harder to display the expertise that you need to in order to give your client the feeling of certainty that they will get what they want by working with you.
The one thing not to do with a lease is avoid reading it. When you have a prospect on the phone, you need to know what’s in the lease – because the quickest way to pour cold water on a deal is to shut down conversation because you don’t know what’s in the lease agreement. If a broker tells someone “I don’t know what’s in the lease, so I sent it to the lawyer,” that’s a great way to not get called back.
So leases are necessary to understand, and it will make you money to understand them well enough to discuss them on your own. But they’re a mile long, they’re intimidating, and you need a magnifying glass to get through one. How can you meet the challenge?
Break it into pieces.
Bob’s solution: “Get a lease form. Don’t read it all at once. Start with the first paragraph. Read it as many times as it takes for you to understand it. Pick time on the train, or at home. Once you understand it, move on to the next paragraph the next day. Do this every day with a new paragraph, make it part of your self-education program. It will take you months, but when you’re done, you will know what’s in that form, and you can have the conversations you need to have without shutting down the discussion. It will get you to the point where you never have to say ‘I don’t know, but I can get back to you on that.'”
If an idea breaks down intimidation, increases understanding, and makes you money — that’s simply one great idea.