Creative Occupancy Cost Reduction: How Tenants Can Take Advantage of Coming Market Conditions

Strategy & Application

Description

Criteria / Determinants

Financial Impacts

1) Acquire Leased Assets
Application — Operating Assets

Occupiers acquires leased property as a means to reduce GAAP occupancy cost

1. Long term occupancy
2. Occupier occupies > 75 percent of the property
3. Depreciation < Rent
4. Helps to be able to allocate high percent of purchase price to land
5. Unfavorable debt structure of owner/bldg; forced sale
6. Available cash (possible use of offshore cash to avoid taxes on repatriation); availability of debt

1. Eliminates Rent Expense
2. Introduces Depreciation
3. Increases net interest expense
4. FASB 13

2) Acquire Leased Assets & Sell
Application — Surplus Assets

1. Occupier should compare sublease strategy and resulting recovery with buying property from owner and selling with restructured / downsized lease or as vacant asset
2. Bring in 3rd party buyer and subsidize purchase in order to eliminate lease (probably requires cash payment)
3. Buy debt from lender and renegotiate with owner

1. Net cost of Buy / Sell or occupancy restructure with 3rd party buyer < Termination costs or NPV of Sublease strategy
2. Unfavorable debt structure of owner/bldg; forced sale
3. Available cash; availability of debt
4. Purchase option (particularly if set at, or below FMV)

1. Eliminates Rent Expense
2. Introduces Depreciation for ST
3. GAAP Gain/Loss on sale (amortized or recognized immediately depending on structure)
4. FASB 144 & 146

3A) Short Term Sale Leaseback
Application — Future Surplus

1. Occupier sells asset with 1-3 year Sale Leaseback
2. Provides buyer time to reposition/re-entitle/re-lease asset and therefore captures higher proceeds than selling vacant

1. Ongoing need for asset over 1-3 year term — employee retention can be issue once closure of site signaled by transaction
2. Market Value > Book Value for owned asset
3. Investor appetite to reposition asset

1. GAAP Gain/Loss on sale (amortized or recognized immediately depending on structure)
2. Introduces Rent Expense for ST
3. Eliminates Depreciation
4. Net interest expense reduced

3B) Partial Sale Leaseback
Application — Partial Surplus

1. Occupier sells asset and leases back only a portion of the Asset

1. Ongoing need for portion of the asset
2. Rent plus opex of retained premises < depreciation plus opex for entire property + lease income for surplus space
3. Investor appetite to accept leasing risk for surplus space

1. GAAP Gain/Loss on sale; if ‘minor’ leaseback Gain/Loss recognized immediately, otherwise may need be amortized over lease
2. Introduces Rent Expense
3. Eliminates Depreciation
4. Net interest expense reduced

4) Move from owned to leased property(s)
Application — Operating Assets

1. Occupier relocates from oversized/inefficient owned asset(s) to smaller leased property
2. Sells vacated owned asset (see 3 above)

1. Efficiency of leased assets drive lower overall occupancy cost

1. GAAP Gain/Loss on sale
2. Transaction and transition costs
3. Eliminates Depreciation
4. Incur rent expense but reduce overall occupancy cost

5A) Asset Swaps
Application — Operating Assets

1. Occupier swaps surplus owned site(s) in exchange for better terms on other leased locations with same landlord or where landlord has other vacant assets suitable for Occupier
2. May be particularly effective where Landlord is about to default on building that Occupier could occupy

1. Landlord interested in acquiring Client Surplus assets
2. Market Value > Book Value for owned asset

1. GAAP Gain/Loss on sale
2. Eliminates Deprecation
3. Relief on Rent Expense
4. FASB 144 (depends on timing)

5B) Asset Swaps — 1031 Exchange
Application — Operating Assets

1. Occupier sells oversized/inefficient owned asset (Relinquished Property) and trade into smaller/more efficient purchased asset (Replacement Property) as a 1031 exchange

1. Market Value > Book Value for owned assets
2. Like-kind exchange for properties located within 50 US States
3. Must be held for business use or investment
4. Timing
1. Replacement property indentified < 45 days of sale
2. Replacement property purchase completed < 180 days

1. No out-of-pocket costs
2. No gain or loss recognized on the exchange of the property
3. Internal Revenue Code (IRC) Section 1031

6) Portfolio Sale
Application — Surplus & OREO Assets

1. Occupier bundles & sells owned Operating and Surplus assets — including those with partial vacancy
2. If Occupier is a Financial Institution consider including Other Real Estate Owned (OREO) properties

1. Market Value > Book Value for owned assets
2. Portfolio Value > Value of assets if sold individually; or makes sale of ‘challenged’ properties achievable
3. Impact of Gains/Loss on earnings

1. GAAP Gain/Loss on sale
2. Eliminates Deprecation
3. Introduces Rent Expense for Sale-Leaseback assets
4. Eliminates OpEx for surplus space
5. FASB 98, 60 & 144

7) Trade lease rights for rent reductions or ability to relinquish space
Application — Operating Assets

1. Occupier trades lease rights for rent/size/ term concessions from landlord
1. Surrender Lease Options — Purchase, Termination, Right of First Refusal (ROFR), Expansion, Subordination & Non-disturbance, Signage, Go-Dark, & Use
2. Substitute Parent for Subsidiary for guarantees
3. Offer ‘must-take’ and extension for relief on surplus space (defer/blend & extend)

1. Lease with favorable terms
2. Certainty of long term occupancy
3. Unfavorable debt structure of landlord

1. Relief on Rent Expense
2. FASB 146

8) Surplus Property Program
Application — Surplus Assets

1. Occupier creates an inactive property program to separate operating assets from surplus
2. Advantage is focus of Program on rapidly disposing of surplus real estate — specialized expertise/rapid action

1. Significant surplus real estate — either via downsizing or M&A related
2. Occupier has concern about impact of disposition program relative to earnings

1. Potentially allows firm to report ‘below the line’ as losses/income from discontinued operations
2. FASB 144,146 & 157

9) Restructure Old (or Get New) Econ. Incentives for Staying
Application — Operating Assets

1. Occupier solicits new or renegotiates existing economic incentives in order to keep sites open

1. Availability and flexibility of Statutory and Discretionary Economic Incentives
2. Certainty of long term occupancy

1. Relief on Rent, Inventory and/or Payroll taxes, other cash incentives

10) Subsidiary Sale
Application — Surplus Assets

1. Occupier bundles Real Estate Assets (owned & leased) with sale of Subsidiary

1. Consider impact of real estate on underlying business transaction

1. GAAP Gain/Loss on sale
2. Eliminates Depreciation
3. Relief on Rent Expense
4. FASB 144

11) Sublease to Landlord
Application — Surplus Assets

1. Occupier/Lessee subleases to Landlord vacant space
2. Advantage to Landlord
1. Controls leasing activity in building or complex
2. Still has credit of Lessor
3. Advantages to Tenant
1. Cap on losses
2. May result in positive Financial Statements impact vs. reserves
3. Avoids further capital expenditures for TI’s and commissions

1. Landlord willing to take leasing risk
2. Likely that Landlord would require sublease rate well below prevailing market rents (plus consideration for TI’s, commissions, and down time)
3. Face rent < Sublease rate to landlord, but below rate Landlord can charge in market
4. Sublease to landlord > sublease to 3rd party tenant (considering all sublease risk and timing)

1. Relief on Rent Expense
2. FASB 146

13) Barter
Application — Operating Assets

1. Occupier pays portion of rent in products

1. Value of Occupier/Lessee products > rental obligation
2. Occupier real cost is marginal cost of products
3. May be most applicable in 2nd and 3rd world economies

1. Relief on Rent Expense