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Corporate Capital Markets

Own Vs Lease Decisions: Key considerations for tenants

Key considerations for occupiers

Questioning historic strategies
Corporate real estate directors are constantly challenged to balance the opportunities presented by a dynamic capital markets environment with the operational and financial goals of their company.

While certain companies have stayed the course and continued with an ownership or leasing strategy driven by long standing financial policies, others have implemented proactive strategies for selected properties, such as sale and leasebacks of owned assets or acquisitions of short-term leased assets, to take advantage of the current capital markets environment that is defined by an asymmetric risk reward relationship between lease term and value.

Many of these financial decisions have historically been driven by the CFO or corporate treasury. However, over the last five years we have seen corporate real estate decisions take a more active role in surfacing these opportunities and evaluating the various economic, financial accounting and tax consequences in order to recommend structures that best align with the company’s operating and financial strategies.

This paper focuses on the broad spectrum of decision criteria needed to effectively evaluate ownership versus lease decisions at both the portfolio and individual property level, and the potential benefits of adopting alternative leasing structures or pursuing sale and leaseback transactions.

Towards new standards for lease accounting

In March 2009, the U.S. Financial Accounting Standards Board (FASB) and its counterpart, the International Accounting Standards Board (IASB) issued a discussion paper, Leases: Preliminary Views. The paper outlined dramatic proposed changes in lease accounting. It advocated that all leases of real estate and equipment be capitalised on company balance sheets in the future. Rather than choosing one of two methods to classify leases today – as operating or capital leases – the new approach will cause companies to recognise an asset representing its right to use leased property and a liability for its obligation to pay rent and other amounts. All leases will be affected – no grandfathering of existing leases is expected to occur.

The Discussion Paper was an outgrowth of a joint project on lease accounting adopted in 2006 by the FASB and IASB to overhaul the U.S. Standard, Statement of Financial Accounting Standards No. 13, Accounting for Leases (FAS 13), and its international counterpart, International Accounting Standard No.17, Leases (IAS 17). The stated objective of the project was to recognise off balance sheet obligations and put leases into plain view on the balance sheet, believing this will provide greater economic transparency. The rules-based nature of FAS 13 and its ‘all or nothing’ outcome is frequently derided by critics who contend that financial engineering drives lease behaviour.

Concerns over off balance accounting escalated with Enron and other notable corporate bankruptcies. FAS 13 is more than thirty years old and has been an ongoing target of concern for the last decade. In 2005, resulting from a mandate under the Sarbanes-Oxley Act, the Securities and Exchange Commission (SEC) issued a report on off balance sheet arrangements and recommended that the FASB reconsider existing standards including lease accounting.