Institutional Real Estate, Inc.

NAREIM Dialogues Spring 2018

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NATIONAL ASSOCIATION OF REAL ESTATE INVESTMENT MANAGERS 42 FASB's ASC 842 and a similar update by the International Accounting Standards Board (IASB), IFRS 16, require tenants to include the future value of their lease obligations as liabilities on their balance sheets. Historically, tenants have noted this information in the less scrutinized footnotes of financial statements. The new requirement is intended to give users of financial statements, such as investors and creditors, a more transparent view of a company's true financial health. This change will affect selected commonly-used performance measures, e.g., return of assets, interest coverage, return on capital and quick ratio as well as loan covenants, credit ratings and the cost of borrowing. Aptly, business pundits, including hands- on real estate experts, are describing the new standard with terms like "bombshell" and "disruptive," even characterizing it as "the biggest change to hit business owners in decades" (Forbes, May 5, 2017). The Compliance Challenge for Tenants To begin gauging the update's scope of impact, RealFoundations, one of the leading professional services firms focused exclusively on commercial real estate, commissioned the first known study to estimate how many commercial real estate leases exist in the world and the possible macro consequences of that finding. "The Inaugural Global Lease Count Study" 1 , a rigorous investigation led by RealFoundations founder David Stanford and Senior Research Consultant Ward S. Caswell, accounts for nearly 4 million office, industrial and retail third- party leases spanning 91 countries. RealFoundations believes that the annual value of those leases is about $500 billion (USD). Researchers derived this number using accepted practices for calculating the total value of investment real estate at the country level and scaling to remove those segments without commercial leases. Although the study reflects lease counts for only about half of the world's countries, due to limited data availability, the findings are still meaningful because the top 25 nations account for more than 80 percent of all global leases. The analysis of an individual company's leasing obligations is an enormously challenging undertaking, especially for those with hundreds or thousands of leases throughout the country and the world. Many tenants need in-house and/ or outsourced, cross-functional teams of specialists to: gather and digitize relevant documents; identify, extract and verify a plethora of key data; and consolidate the information into consistent systems for financial reporting. In most cases, tenant companies have to purchase and implement new software solutions while some have gone as far as re-designing IT systems and processes. Tenants must also contemplate the difference between data and information. What do the data mean? Once the data are collected and consolidated, how should the company analyze and use the data? What metrics should the company develop that help enhance corporate value and mitigate risk? 1 To view The Inaugural Global Lease Count Study and for additional information, visit http:// count-study. The $ 500 Billion DISRUPTION If you're not already talking with the investors you serve about the potential effects of the Financial Accounting Standards Board's (FASB) new lease accounting standard, you're running late! There is urgency in having this conversation — which really should be an ongoing dialogue — as the update will most certainly change tenant behavior and key marketplace dynamics in ways that could significantly impact investors. Ed Lubieniecki, Enterprise Managing Consultant, RealFoundations Barry Faulkner, Senior Managing Consultant, RealFoundations

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