On many CFO and financial executive’s Urgent Issues or Focus List, real estate often doesn’t make the top ten. Why? I think in part it is because the impact of a real estate decision is spread over many categories of the Profit & Loss Statement. (I won’t get into FASB ASC 842 even though it is one of my favorite topics — for now anyway, keeping watching this space for future posts)
Often financial analysis of a lease decision is based on the rent and operating expense being paid now vs. the rent and operating expense on the new lease. If the impact is acceptable, the company moves forward. Simple enough, right? Perhaps too simple.
Why? Expenses related to a lease are generally as follows:
- Operating Expenses (passed through by Landlord, usually inclusive of Property Tax and Insurance although often further broken out if paid direct by Tenant)
- Utilities (not included in charges above)
- Repairs and Maintenance (that are responsibility of the Tenant)
- Relocation Expense
- Furniture, Fixtures, & Equipment — Capital Expense and Depreciation
- Technology — Capital Expense and Depreciation
- Leasehold Improvements – Depreciation
There can be others of course based on specific uses, although the above are common across most operations.
Any comprehensive analysis needs to consider all of these costs. More importantly, you need to compare not just the current rental rates, but instead the rent amounts actually appearing on the P&L — typically a straight lined value. In today’s market, the SL rate of an old lease can be significantly below the SL rate of a new long term lease.
In addition, look closely at fully amortized leaseholds and other depreciation items that may be coming off of the books at the expiration of the current term. A renewal in an existing space may provide significant savings even when rent increases if the amortized numbers are significant.
The key to correct analysis is habit. Set up a template that works for your business. Many packaged real estate analysis solutions focus on making predictions based on future escalations. What the last roller coaster dip in the economy should have taught us is that projections are simply guesses — and often not good ones.
Instead focus on the certainties of a lease obligation and their impact on your business. You may be surprised after looking at the cumulative effect of all of the categories mentioned above and decide to set real estate priorities a bit higher on your Focus List.