Could Proposed Accounting Rules Throw CRE Investors Off Balance?


Even as new accounting rules propose to bring property and equipment leases onto company balance sheets, the new rules will leave certain other financial obligations, namely service contracts and leases with terms of 12 months or less, as off-balance sheet items, according to a report from Fitch Ratings.

In some cases, Fitch reports, extension options and variable lease payments may also be excluded from being capitalized as a lease liability under the new proposed accounting rules.

While the proposed rules are intended to more accurately reflect the economic substance of leases, the value of the rules hinges on whether they are successful in increasing – or at least not further obscuring — financial transparency for investors and analysts, said Fitch analysts John Boulton, Alex Griffiths and Frederic Gits.

With the Sept 13 deadline fast approaching for public comments on the new proposal, CRE groups and other stakeholders are weighing in, and in some cases doing battle in the court of public opinion, over what they believe will be the dramatic effects the new accounting rules will have on landlords, tenants and the broader CRE market.

While almost all parties agree that it is vital for companies to divulge information about cash payments and the nature of leased assets in ways that allow investors to make judgments in asset financing decisions, how best to do so remains a point of disagreement.

Corporations often adjust their balance sheets in an attempt to reflect a fair estimation of implied debt from leases, however, critics claim that these adjustments are inconsistent, and frequently understate the lease obligations.

Companies implementing the proposed standard will face a heavy administrative burden since they will have to collect and input a substantial amount of data and perform complex calculations to determine the amount to be capitalized. Most companies have not developed a corporate strategy to address the issue or have been slow to start their transition plans, according to a recent white paper by Boston-based tenant representation firm Cresa.

“The bottom line is the need for transparency, and the biggest hurdle is how companies will maintain comprehensive, comparative and valid information in order to perform this analysis,” said Michael Hetchkop, senior vice president of lease auditing at Cresa Washington D.C. “It’s going to be more of a challenge for companies to make sure the information they have is complete.”

Reaching a solution has proved difficult for accounting standard setters, who are faced with conflicting and sometimes contradictory definitions of what exactly constitutes a lease, defining the lease term, and measuring payments, the Fitch report said.

“Add political sensitivity due to the size of the lease market and you have a potent mix. It is no surprise that progress towards a solution has been slow,” Fitch said.

Cresa’s Hetchkop agreed.

“This has been a gut wrenching process since it started four years ago, with 800 comment letters [for the previous exposure draft], then going back to square one. And now, another comment period, and who knows what will happen at the end?”

A recent letter to the FASB and IASB from a diverse group of more than 30 trade organizations, including the Roundtable, International Council of Shopping Centers (ICSC), CCIM, American Trucking Association and Equipment Leasing and Finance Association expressed their displeasure with the latest proposed leasing standard.

“In its current state, it is our opinion that the proposed leasing standard may result in substantial costs to businesses, lack any benefits for investors … will increase complexity, drive economic activity rather than reflect it and will create adverse unintended consequences and pressures upon financial reporting systems. Further, the proposed leasing standard will not result in more decision-useful information compared to that currently available. If our concerns cannot be addressed, then it is our belief that the proposed leasing standard should not be finalized.”

FASB/IASB will begin a month-long series of public roundtable discussions on four continents on Sept 10, starting in São Paulo, Brazil. After weighing the feedback, a final standard is now expected to be issued in early 2014.

The new standards would be effective no earlier than annual reporting periods beginning on January 2017, but would include a two-year look back provision.


Source: CoStar


New Idea: Third-Party Solar Finance For Commercial Property


With recent announcements by the White House reinvigorating solar energy goals through the Department of Energy’s SunShot initiative, the costs of solar are expected to continue their trend downwards to eventually meet those of conventionally generated electricity.

The most recent initiative makes it a goal for solar to get there by the end of this decade.

These goals don’t come only from government offices.  Laboratories too are leading the way: technological advances are also helping along the trend, as silicon may be able to be replaced as the main ingredient in solar panel construction.  A recent discovery that a light-absorbing material known for a century may work in solar panels and dramatically increase their efficiency has the industry talking.  Thanks to the combined developments, the cost per watt of solar-generated electricity may fall to the 10-20 cents per watt range where fossil fuel-generated electricity resides.

All that said, the opportunity for commercial space users to take advantage of these new technologies and for commercial landlords to convert their properties into energy-producing ones remains mired in the financial barriers and customs of an industry that views (and pays for) property improvements for multi-tenant buildings in very specific ways.  To answer the question of how the costs and benefits of solar improvements are apportioned usually needs to begin with how such improvements are paid for.

One California company says they have used real estate legal norms to address this problem. Working with a leading law firm, EPR Squared, a real estate firm specializes in cracking the tough problem of opening commercial rooftops to solar.  In solar improvement,  as with most other features of commercial property usage, the all-important capital source is the third party financier.  But the territory is new and forms and deals have little precedent to work with.  Establishing revenue flows on a tenant or space subdivision basis to cover construction costs and to apportion energy-generation benefit requires a new kind of real estate deal. EPR Squared says they’ve constructed such a boilerplate.

[…] 90 percent to 95 percent of commercial building rooftops remain essentially beyond the reach of third-party financing, according to real estate research firm data cited by Energy Producing Retail Realty, Inc. (EPR Squared, EPR^2) Founder/CEO Chris Pawlik.

“When you have a commercial building with multiple tenants,” Pawlik said, third parties “can’t technically finance those unless the owner takes it on, [and] commercial owners won’t do that.”

Third-party financiers, he explained, “can get an agreement signed or financing in place because they have the credit of the off-taker that takes care of the risk.” With a twenty-year commitment, third-party financiers have certainty that their loan will repaid.

But, Pawlik said, “owners typically own properties five to seven years and tenants are typically in properties five to ten years. You can’t have a ten- to twenty-year agreement in situations like that.”

EPR Squared’s idea is to create a real estate interest on the property and have it be a separate interest from the improvements and from the land.

 It is similar to agreements with property owners for cell tower and billboards, though, Pawlik stressed, the solar legal structure is not identical.

DLA Piper, which Pawlik called “the gold-standard, top-tier law firm” for commercial real estate, “has finalized the form documents we need to take to the owners to show them how this structure would work.”

EPR^2 has “a dozen or so deals in the pipeline with groups that have either portfolios of properties or single properties,” Pawlik said. The first deal, he explained, must be one that demonstrates to the 60,000 California real estate brokers, agents and mortgaging agents that “this is almost identical to a real estate transaction.” When they see commissions in it for themselves, he said, “we can really scale the idea and bring it to a size at which pension funds and insurance companies will start looking at it.”

Source:  Commercial Source

VIDEO: Jerry Anderson, Matt Rotolante Talk Florida Ports Real Estate

Jerry Anderson, Regional Director for the State of Florida and Matthew Rotolante, CCIM, SIOR, Managing Director of Sperry Van Ness talk Florida Ports Real Estate in an interview with Douglas Dennison, the radio show host of the Florida Commercial Real Estate Show.


Demand For Cold Storage Space Heating Up

floral warehouse

Floral Logistics of Miami Inc. occupies one of Miami-Dade County’s largest cold storage facilities with more than 250,000 square feet under refrigeration in a 350,000-square-foot building.

Yet, company executives including sales and marketing director Linda Nunez are pondering how to increase the volume of flowers and produce Floral can store at the 3400 NW 74th Ave. building about a mile west of Miami International Airport.

Floral, which picks up imported products from the airport before cooling and distributing the goods, has enough room in its facility to avoid taking on another lease.

“We definitely have to maximize the number of pallets we have and also utilize existing space,” Nunez said.

But other cold storage users who want to expand face significant challenges.

The county’s shining tourism and trade industries, growing population and resurgent economy are generating heavier demand for perishable goods. That puts pressure on companies that store and ship the products to expand their businesses.

Cold storage represents 5 percent to 8 percent of Miami-Dade’s industrial inventory, according to Sperry Van Ness LLC managing director Matthew Rotolante. That range is likely to increase as more perishables are imported into the county, which already has the nation’s largest floral import business with more than 90 percent of U.S. flowers passing through the airport.

“What we see is a lot of demand from hotels and cruise ships” for refrigerated and frozen goods,” Rotolante said.

Nunez notes the volume of produce handled by Floral has significantly increased to account for about 45 percent of the company’s inventory. She cited a boost in tropical food items like yucca that are sold in South Florida supermarkets throughout the year.

No Spec Market

Cold storage supply space is limited, and vacancies are rare in the sector. Real estate firm Transwestern reports a vacancy rate of less than 5 percent for Miami-Dade’s 8 million square feet of refrigerated and freezer space.

“The market is very tight,” Transwestern managing director Ben Eisenberg said. “Our team represents a company looking for space, and we can’t place them right now.”

Earlier this month, Eisenberg and Transwestern brokers Thomas Kresse, Walter Byrd and Carlos Gaviria represented RREEF in a 40,000-square-foot long-term lease with seafood producer and distributor Marine Harvest USA LLC at Beacon Centre-Building 22 in Doral. Marine Harvest had been subleasing the facility. But when the previous tenant’s lease expired, the company moved quickly to sign a direct deal with the owner of the 8500-8550 NW 17th St. building.

“Obviously that was a great benefit to the landlord with no downtime” between leases, Eisenberg said.

Supply is also being constrained by a lack of new construction. Cold storage facilities are too expensive for a landlord to build speculatively. Converting traditional warehouses to refrigerated or freezer facilities is also costly.

“It’s still four to six times more expensive than building regular industrial space,” said Zac Gruber, senior vice president at Miami-based Easton Lynd Management LLC.

“That limits the market too much for industrial landlords,” Gruber said. “If you see anything built on spec, it would be for an existing user, a build-to-suit.”

Jones Lang LaSalle Inc. managing director Steve Medwin estimates a cost increase of $30 to $100 per square foot to build out cold storage facilities. That doesn’t mean industrial landlords should ignore the niche, however.

“There is demand,” he said. “If someone made an investment in that, they may be rewarded. But meeting the exact needs, trying to anticipate that, would be difficult.”

Rent Premium

The long-term rental returns for industrial landlords could still outweigh the additional construction expenses.

Gruber estimates an owner could receive a $2-to-$3 per square foot premium on rents for refrigerated space.

“That depends on the quality of the cooler, sophistication of the landlord and how much work is done in there,” he said.

Potential rent appreciation was the driving force behind a California investor’s $8.75 million acquisition of a three-property freezer facility in northwest Miami-Dade in May. Rotolante represented the buyer, Miami Business Park LLC, in the purchase of 6960 and 6831 NW 36th Ave. and 7007-7025 NW 37th Ave.

The facility was more than 40 percent vacant when Miami Business went under contract, Rotolante said. Before closing, the company received lease offers from several large national tenants willing to pay substantially higher rents than existing tenants.

“That shows the demand for this product is popping right now,” he said.

For Floral Logistics, the solution to its growing space needs could be racking.

Nunez said the company plans to have racks installed at its facility by December. The building has numerous temperature “zones” and 38-foot tall ceilings, which is well above the norm for South Florida industrial facilities.

“We can have a pallet on the floor and triple our space by racking,” she said.

In rare instances, users like Preferred Freezer Services LLC opt to build their own cold storage facilities. Preferred began construction this month on a 118,000-square-foot facility in Hialeah Gardens. Once completed in March, the facility will be the company’s third in Miami-Dade.

Preferred and other companies have to take such measures because institutional landlords are “more conservative and not comfortable spending money on these improvements” despite the potential rental revenue, Eisenberg said.


Source:  DBR

Investors, Users, Cap Rates, And The Income Approach To Commercial Real Estate Valuation

cre valuation

The world is awash with capital.

It is global and digital. Significant amounts are transferred in a matter of seconds each day. Like weather shifting in the atmosphere, this capital moves in measurable and often predictable ways into various asset classes. As with lightning, tornadoes, and hurricanes, however, these flows can also be fickle and unpredictable, as we have witnessed in the recent recession. The goal, then, is to improve the predictability of these cash flows by creating models that enable us to value the underlying assets in an optimal fashion, and to thereby enable investors and businesses alike to make decisions in a timely and reliable manner. It is the model for valuing commercial real estate on which I focus in this article.


The methodology for calculating the value of commercial real estate is complex and comprises myriad variables. Commercial real estate often competes against stocks and commodities for capital, but there are several large differences between them. While stocks and commodities are standardized contracts that trade more often and have options and future derivatives so that pricing is transparent at any given moment in time, commercial real estate is non-standardized and trades less often. Therefore, the pricing of commercial real estate can be more difficult to verify. I will make the case that if certain methodologies are used, commercial real estate can be priced quite accurately.

Similar to stocks and commodities, commercial real estate is subject to supply and demand. Early in my career I worked on the Chicago Board of Trade (CBOT) Commodities Floor, so I speak from experience when I tell you that many stocks and commodities have supply and demand factors that change drastically over short periods of time which result in large shifts of pricing overnight—or even during the same day. Conversely, many of the supply and demand variables in commercial real estate can be forecasted over longer timelines, and change less often and to a lesser degree. Therefore, the pricing of commercial real estate tends to shift more slowly.


To begin to understand the true value of commercial real estate, one must understand the dynamics behind supply and demand. At the core of this dynamic is the existing NOI (Net Operating Income) or the potential NOI that the property will provide. In the same way that stocks and companies are valued based on their EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), commercial real estate relies on NOI for valuation. Commercial properties with long-term leases containing fixed terms have NOI that is very predictable. These properties are typically the most reliable and standardized assets among commercial
real estate. They trade similar to bonds, and are often called “Coupon Clippers.” However, not all properties have long-term, stable leases, and this is where commercial estate valuation gets tricky. It is not simply the property’s current NOI that affects its value, but rather what the market believes will happen to this NOI in the future. Even if there is a long-term lease in place with fixed terms, the lessee may go bankrupt and reject the lease as part of its reorganization plan. It may also choose to cram down the lease if the market allows it to do so. In some cases, a zoning law change or simply the path of progress will provide the opportunity for redevelopment to the highest and best use, which will in turn generate a higher exit sale strategy, such as with a condo tower, or potentially an alternative use as we saw with Merrick Park in Coral Gables converting from industrial use to high-end, retail mixed-use. In some cases, redevelopment is not even necessary in order to capitalize on a higher NOI,and one simply needs to find a new tenant that can make more money in the specified location and therefore pay more rent.

The use of the NOI to derive value involves one other variable, which is the Capitalization Rate or “Cap Rate.” Different asset classes involve different risks and therefore two properties with the same NOI will likely trade at different prices based on the Cap Rate investors will apply to the property. The Cap Rate calculation is the inverse of the Price/Earnings ratio many investors monitor when dealing with stocks. Earnings are the equivalent of NOI. Instead of Price/Earnings, it is Earnings/Price or NOI/Price. Cap rates tend to vary by geography and the type of asset. The highest quality assets in core markets with the most upside and/or the least amount of risk will trade at lower cap rates, and vice versa for assets that are located in non-core markets which may have less upside and/or carry more risk.

The Trouble With Appraisals

The most difficult factor in commercial real estate is that no property is exactly like another, so the potential NOI can be a moving target. Every property stands on its own two feet. For this reason, appraisers are often employed to derive value for tax and legal purposes. While appraisers will use comparable sales, cap rates, and rental rate trends to value the property, these factors are typically backward-looking. Highest and best use is something that appraisers often cannot accurately include in their report, if only because they are not working with the current buyers in the market who may be setting new trends. Appraisers may not always account for the possibility of variances and/or public hearings to change the zoning laws to allow for larger development or alternative uses. They also may not be aware of new tenants in the market that can pay higher rates, or existing users that are willing to pay more for the real estate.

Regardless, appraisals play a very necessary role in and lie at the heart of the value discovery phase in a SARE (Single Asset Real Estate) bankruptcy case. They facilitate a push and pull process with each side attempting to provide expert witnesses and data that allow them to anchor value in a manner that will support their respective positions. Strategies vary and can include a 363 sale, cramdown, reorganization, relief from stay, and more. The stakes can be high and will often hinge on the ultimate value assigned to the asset and/or the legitimacy of plans to increase that asset’s value, so it is often worthwhile to leverage as much expertise as possible to support the correct value. As part of an appraiser’s research and in order to verify the data and ensure an arms-length transaction, appraisers will spend a large amount of time calling the commercial real estate brokers who sold or leased the properties referenced in their reports. In such a case, an active, veteran commercial broker will be more in tune with the value of a property than an appraiser, and also will be more aware of the inherent variables that affect that value. This is not to say that a commercial real estate broker will always know the exact value, but rather that that broker receives empirical feedback daily on active listings and is on the front end of the market and can therefore more accurately read the pulse of the market.

“In essence, appraisals are necessary to determine value, but when combined with the testimony of a credible broker, a more accurate valuation may be obtained. This is especially important when attempting to prove the legitimacy of a reorganization plan, or deciding whether a 363 sale strategy is feasible.”

Active Listings As A Tool

The truth of the matter is that an active listing itself is the ultimate test of true value. The FDIC has guidelines in place for assets in receivership, also known as “Loss Share Banks.” FDIC guidelines recommend the use of an experienced and knowledgeable broker for every REO property, and that reductions in price only take place after a certain amount of time has passed, in most cases three months. Simply listing a property, however, does not guarantee results. In order to ensure that this live testing of the market is truly indicative of value, the bankruptcy estate must hire a commercial real estate broker who employs methodologies that consider all possible uses, and perhaps most importantly, who helps ensure that every possible purchasing group has the opportunity to review the property. While it may appear to be common sense that a broker should enlist the entire market, including other brokers, to sell the property, one must consider the human motives inherent in such a process in the same way that a creditor must consider the motives of the debtor and vice versa. As the price of a property falls below the market value, the pool of buyers increases significantly. In many cases, if a property is priced below market value, the broker will not need to spend any money marketing the property, and neither will that broker need to solicit cooperating brokers to bring their customers to the table and thus be forced to split the commission. One must also consider that in such a case the property will sell faster.

So in fact, we see that brokers are often incentivized to manipulate a price to be lower than market value in order to save on marketing fees, to pocket both sides of
the commission, and to spend less time on the property. Of course, a good and ethical broker will rise above such tactics and take the time to add value to the asset
through creative property management techniques that will lower expenses, while at the same time bringing tenants to lease up the property. If capital expenditures, such as tenant improvements, must be made to implement these strategies, then each instance must be measured on its own merits based on a present value analysis. A good commercial broker, such as those with the CCIM (Certified Commercial Investment Member) designation, can advise on the benefits and disadvantages with a breakeven analysis of such an expenditure on a present value basis using IRR (Internal Rates of Return) and NPV (Net Present Value). Both the reduction of expenses and the increase in rental income will enhance NOI in the short term. This increase can then be leveraged at the market capitalization rate for that specific asset class, thus exponentially increasing the value for the bankruptcy estate.

A Real-Life Example

An example of such a scenario might be spending $90,000 in tenant improvements to land a good credit tenant in a retail center who will sign a 5-year net lease (expenses paid by tenant) with a total value of $720,000, or $144,000 per year for a 6,000 sq. ft. retail space at a rate of $24/ft. If we assume the cap rate of comparable retail space is 8.5%, then we can calculate that the increased income of $144,000 per year will yield an increase in price of the asset by $1,694,117 ($144,000/8.5% = $1,694,117). Therefore, the $90,000 spent to attract this tenant results in a return of over 1,800% to the bankruptcy estate when the property
is sold—a tidy profit, to say the least. Not all scenarios are so easily calculated or so handsomely profitable, but you get the idea.

Additional Considerations

As a final note, many properties in bankruptcy are owner-operated. While there is always capital readily available to purchase income property that is occupied, owner-operated vacant properties such as manufacturing facilities can be more problematic to sell. An investor who is willing to purchase a vacant, single-tenant property will often pay less, because the investor is discounting for the lease up period, the tenant improvements, and the risk associated with owning such a property. On average, there can be up to a 20-30% premium in the value that a user can afford to pay above and beyond that of an investor. In addition
to the discounts previously mentioned, this 20-30% premium is due to what I call the “Five Pillars of a User Purchase Decision.” These five pillars are

  1. Interest Deduction on the Mortgage
  2. Depreciation (which include accelerated depreciation)
  3. Paying down the Principal
  4. Appreciation of the Asset, and
  5. The ability to employ subsidized financing by the Small Business Administration

Often, a bankruptcy estate sale is not willing to entertain such financing, but the small business loan program allows qualifying participants to purchase a property
with as little as a 10% down payment with fixed terms as long as 10 years, and at a very competitive rate. This possibility may drive up the value of a property significantly. In addition, the underwriter will look to the EBITDA and cash flow of the company to service the debt, and so as long as the property appraises, the deal can be struck at an even higher price than what market rents might support. It is plausible, then, that a bankruptcy estate might receive subsidies on both sides of a 363 sale with a cramdown on the existing SBA loan and a higher value provided by the financing of a new SBA loan.

Final Remarks

The key in all cases is finding the right user or investor for the property. A user who can purchase “off the rack” as if the property is tailored to fit that user’ operations will often pay more than another user who must make significant improvements to the property. An investor who is willing to pay today for the pro forma of higher cash flows in the future will often pay more than an investor who is only willing to pay for current cash flows. A broker who is familiar with the
property’s market and already knows the users and investors in the community will be instrumental in assuring that the maximum value is obtained for the bankruptcy estate.
This article originally appeared in the print edition of The Bankruptcy Bar Association (BBA) 2013 Journal.  Click the following link to download the complete report: BBA 2013 Journal