Mixed Signals: Nonresidential Construction Forecasts See Little Improvement Near-Term

COSTAR SAYS: While signs of a tentative recovery in the economy continued to appear, including reports issued this week on the fourth-consecutive month of improving new-home sales in July and a sizable increase in durable goods orders by manufacturers' orders also for July reported by the Commerce Dept., it is also clear that investors will be grappling with the fallout from the near-collapse of the U.S. economy for some time to come. This past week, three separate news items reflect the degree that investors and corporations are struggling with commercial real estate valuations and how the rules for assigning that value already are changing.
· A new survey from Jones Lang LaSalle and CoreNet Global survey finds virtually all corporate real estate executives are unprepared for proposed FASB/IASB lease accounting changes that could occur in less than two years.
· The Investment Committee of the Board of Trustees of Teachers Insurance and Annuity Association of America has approved a modification to the investment guidelines of the TIAA Real Estate Account effective Nov. 1, 2009.
· The California Public Employees' Retirement System has submitted for investment board approval a new accounting policy that imposes fair value on all aspects of its real estate portfolio.
The items are all unrelated except for the fact that each has come about as a direct result of events leading up to the recession and subsequent collapse of CRE property values. Lease Accounting Changes - a Stealth Issue Let's start with the Jones Lang LaSalle/CoreNet survey because the lease accounting changes it addresses will affect every size and type of business in the U.S. The recent survey of U.S. corporate real estate (CRE) executives found that a large majority is substantially unprepared for a proposed major change in national and international accounting treatment of real estate lease obligations. The proposed changes are designed to standardize the treatment of leases as financial obligations (much like a mortgage payment) as opposed to an operating expense. The changes are intended to improve the transparency, credibility and usefulness of lease accounting. Under new standards presented on a preliminary basis by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) slated to be issued in 2011, all leases of real estate and equipment will have to be capitalized on a reporting entity's balance sheet. The changes will affect both the entity renting the property and the owner collecting rent payments. "Whether a firm is public or private, this change would impact literally every item a corporation leases -- not just real estate," said Mindy Berman, managing director of Jones Lang LaSalle's Corporate Capital Markets practice. "Everything from computers to trucks, an ATM kiosk to a floor in an office tower, would have to be capitalized on a balance sheet." Berman said lease accounting has been a stealth issue in light of more immediately pressing business matters in the current economic environment and other major accounting changes made recently. The Securities and Exchange Commission estimated in 2005 that U.S. public companies will be forced to capitalize approximately $1.3 trillion in operating leases under the new rules. Industry experts estimate that approximately 70 percent of all operating leases are for real estate, impacting balance sheets by $1 trillion or more. According to the World Leasing Yearbook 2009, total annual leasing volume in 2007 amounted to $760 billion; yet many of those lease contracts do not appear in an entity's balance sheet. According the Jones Lang LaSalle/CoreNet survey:
· 90% of respondents noted that 95% or more of their company's real estate leases are currently structured as operating leases-responses which cut across all business sectors and everything from small to large lease portfolios.
· 83% of respondents indicated the proposed changes would cause a significant (19%) or major burden (64%) on their company's administrative requirements.
· More than a third of those surveyed (39%) agree or strongly agree that the increase in lease-related expenses on their income statements will result in a meaningful detriment to earnings.
The proposed accounting changes are still in the public comment stage and are subject to change before being adopted. Stymied by Limits, TIAA To Increase Debt Ratios; Refinance Portfolio The Investment Committee of the Board of Trustees of Teachers Insurance and Annuity Association of America recently approved a proposed modification to the investment guidelines of the TIAA Real Estate Account effective Nov. 1, 2009. The modification stems is intended to address the rapidly declining value of real estate property values in the pension fund investment firm's portfolio and the unchanging amount of debt on those properties. TIAA Real Estate's current investment guidelines prevent it from incurring debt beyond a 30% debt to equity ratio. As of Aug. 18, 2009, the aggregate principal amount of the account's outstanding debt was approximately $4 billion and the account's debt to equity ratio was approximately 42.5%. The account's loan to value ratio was approximately 31.3%. As of June 30, TIAA Real Estate Account owned $10.6 billion in real estate properties and interests in joint ventures. As a result, the account has not been able to incur or refinance any debt on its properties since the fourth quarter of 2008, due to the recent decline in the value of the account's real property investments. Under the new investment guidelines the account will maintain outstanding debt in a total amount not to exceed the current $4 billion level. The change will give the account the ability to refinance its debt and/or extend maturity dates. Over the course of the next two years, though, TIAA wants to whittle down its debt-to-equity and loan-to-value ratios to less than 30% -- a process that could likely involve the sale of some assets. Fair Market Value Accounting The third news item concerns The California Public Employees' Retirement System (CalPERS), which is expected to approve a new accounting policy that imposes fair market value accounting policies on all aspects of its $20 billion real estate portfolio. Fair market value accounting's central principle is that an asset must be valued at its current price if sold today into an orderly market. The policy would be effective immediately upon adoption and would supersede all previous CalPERS real estate appraisal policies. The objective of the policy change would be to provide an opinion of market value for the real estate assets and CalPERS ownership interests on an annual basis or in conjunction with the consolidation, termination or transfer of real estate interests. And, to calculate and report time-weighted returns accurately for the CalPERS real estate portfolio at the portfolio, sector and individual partnership level. Some key revisions for the appraisal and valuation policies include an allowance for:
· More frequent appraisals, if deemed to be in the best interest of CalPERS
· Fair market value dispute resolution procedures to be coordinated by the Investment Office
· Emphasis on the importance of providing transparency for investors, the CalPERS Board, and other stakeholders.
At the same time, the revisions give CalPERS the right to exempt some real estate assets, if deemed to be in the best interest of CalPERS. CalPERS did not detail what impact the changes will have on its current portfolio. For more information on Houston office space, Houston retail space or Houston warehouse space and Houston industrial space, please call 713 782-0260 or see my web site at : www.houstonrealtyadvisors.com Offer opportunities for Houston office space. Thank you for your interest.
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Thanks,
Ed A. Ayres
Houston Realty Advisors, Inc.
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