By John Salustri
Back in 2016, the Financial Accounting Standards Board promised to “upgrade” (to use its term) lease reporting standards, with the goal to “improve financial reporting about leasing transactions, and in so doing gain greater transparency for investors and other stakeholders.” IAMC members report that the upgrades did the trick, and transparency to investors has improved.
But internally, hitting that goal wasn’t an easy road to travel, and there’s still a lot of sorting out to make the process organic and efficient. We’ll get to that shortly. But first, the good news:
“Yes. It did accomplish what FASB wanted to do,” says IAMC Fellow David C. Hocker, CFM, a member of the original IAMC task force charged with studying the impact of the then-pending changes. He says reporting accuracy has gone up as a result. Hocker, who is enterprise property group executive at Adient US LLC in Plymouth, MI, manages a corporate portfolio of roughly 280 global assets, some 75 percent of which is industrial.
New FASB regs “require forethought in how you’re going to address the additional reporting requirements, and then it requires execution to collect the data.”
— Bob Schneiders, Iron Mountain
Roger Nesti, director of International Real Estate for Kellogg Company, also sees the upside. At the company level, it did bring more transparency “to all of the leases we had out there,” he says, which includes a portfolio of some 39.7 million square feet, which includes manufacturing, warehousing and office assets in 42 countries. “We knew what we had from a real estate perspective as the global portfolio is managed from our headquarters in Battle Creek, MI. The greater challenge was tracking leases on things like copiers, computers and forklifts.”
As for real estate itself, Kellogg, like many major corporations, already had the essential information at hand. “We were already summarizing our major locations in our footnotes, and we regularly publish for internal purposes our owned and leased locations by use and region, along with the lease obligations, so I don’t think it had much impact in our department.”
The new FASB rules “definitely provides more transparency,” says Bob Schneiders, who as VP of Transactions and Global Lease Administration for Iron Mountain, supports the oversight of a mostly industrial portfolio of 90 million square feet in approximately 50 counties. “Operating leases were footnoted before, and now they go squarely on the balance sheet, and people can understand the liabilities associated with long-term leases.”
Now for the Bad News
The upside for investors is that they receive better clarity with respect to a corporation’s lease obligations. However, it does require more sweat-equity on the part of the corporations, “both upfront and ongoing,” says Schneiders. “It requires forethought in how you’re going to address the additional reporting requirements, and then it requires execution to collect the data.”
And even then the upgrade in transparency isn’t perfect. Hocker echoes the sentiment of other members who say it’s nearly 100 percent. Nearly?
“One hundred percent would be nice,” says Hocker. “But in any global corporation, you’re dependent on so many people to help provide the data, not just on Real Estate.” Those other people in Adient’s structure, are: Purchasing, which handles the vehicle fleet; the IT Group, which leases copiers and fax machines; and the Logistics Department (a subset of Purchasing), which handles 3PLs.
(It should be noted that Adient, a spinoff from Johnson Controls, is a late-comer to FASB compliance. While most corporations had to comply by year-end 2018, Adient’s deadline came this past September. “Given the date we went public, we gained the additional year,” says Hocker.)
“I find myself regularly educating the folks outside the US on how to properly record leases. The Finance people in the global regions don’t have first-hand knowledge of US GAAP.”
— Roger Nesti, Kellogg Company
Standardizing on so many variant items demands a lengthy learning curve for every large corporation, and he cites the 3PLs as just an example: “There’s a whole rat’s nest of 3PLs, some with an embedded square footage, which should really fall into real estate. Others are essentially a service contract that provides a rack position and a shipping agreement, which is really a service agreement and not real estate.” Discerning between the various types of leases is typically new territory for Purchasing, and the learning curve starts all over if someone switches jobs.
That’s a major issue if consistency is the goal, which it is. “We try to query regional finance leaders with specific questions concerning leases, mostly around rental rates, escalations, expiration dates and renewal options on a monthly and quarterly basis the same way every time so there’s muscle memory,” says the Boston-based Schneiders. “People come and go all the time, and new people don’t always know they’re going to be asked to push this information back to the CRE function. The more consistency and muscle memory you create in your information-collection process, the better people become at actually furnishing the data.”
FASB may have been a near-non-event for Kellogg, but it wasn’t without its challenges. Real Estate had a workable software system, but it wasn’t up to the new task. “Obviously we had to change some internal metrics based on the things that go on the balance sheet,” Nesti says. Those metrics included reporting not only lease terminations but also “the probabilities of renewing or leaving and how we measure those considerations.”
Much as in Adient’s situation, the inter-departmental communication also needed tweaking, especially on a global basis. “I find myself regularly educating the folks outside the US on how to properly record leases,” says Nesti. “The Finance people in the global regions don’t have first-hand knowledge of US GAAP.”
A Consensus of Opinion
Hocker notes that many IAMC members are in the same boat. At this year’s IAMC Fall Summit in Milwaukee, Hocker moderated a discussion on the FASB regs, and as various attendees voiced their concerns, “I could see nodding heads around the room,” he says.
Talking with colleagues in Milwaukee showed Hocker that “We’re all in the same barrel,” especially when it came to issues like software integration. One of the task force’s original recommendations was for “integrated systems so the real estate database isn’t firewalled, or at least it’s accessible without a lot of intervention. That way, we could all spend more time analyzing data rather than validating the inputs.”
Needless to say, the dialog that took place in Milwaukee “was refreshing and affirming.” The common cry was that “Leadership won’t pay for the additional software package,” Hocker recalls. “But did anyone think of how much time and effort goes into maintaining multiple databases?”
Beyond rejigging metrics, Nesti labels the software issue Kellogg’s “biggest challenge. We have a centralized location for the world. Our solution was fairly easy, but it wasn’t seamless.”
“The Treasury folks are contacting us more frequently to ask us about real estate transactions, which was infrequent before. That’s a good thing.”
— David C. Hocker, CFM, Adient US LLC
First, they had to collect the data from 42 different countries. “We had to go to each one because they all pay their bills locally,” he says. “Even though everything rolls up eventually to Kellogg, it doesn’t come up to us in the granular level that Finance needs, so there was a lot of interaction with the local finance people to gather all of this data.
“Now, we do a data dump into a new system that we’ve adopted,” he continues, “and we have a team of 10 or so people in a service center in Mexico that handles all of the lease accounting for the company.”
Iron Mountain and Adient also hired teams to deal with life post-FASB. “There are a lot of people who touch documents, and many of them are in foreign languages,” says Schneiders. “So we used an outsourced consultant to make queries on our behalf,” and to confirm such data as rents, escalations, renewal options and the likelihood of exercising those options.
“The Treasury Group added staff to facilitate data accumulation and input,” adds Hocker. They leveraged a third-party software provider to help that whole process. “What remains to be seen is how everybody reviews the book of work once this third party goes away.”
Unfortunately, that’s an issue beyond Real Estate’s control. As one Milwaukee participant put it, in a large corporation, “Making a blanket change to corporate software systems is like talking to the wall.” The irony is that, as another attendee said: “We’re stuck with multiple databases in an environment that’s forcing more transparency among departments.”
Strategic Considerations
In FASB’s wake, reporting might be different, but for Kellogg, the strategic approach to real estate hasn’t changed, says Nesti.
Any strong Fortune 500 corporation that would still attempt a sale/leaseback needs to reassess that product in contrast with the cost of funds, “any company that can borrow money at two or three percent,” Hocker says. “On a sale/leaseback you’re probably getting an eight to a 10 cap, so why would you want the higher obligation on the books?”
For Adient itself, there is one major upside, and it comes in the information flow between departments. “The Treasury folks are contacting us more frequently to ask us about real estate transactions, which was infrequent before,” Hocker reports. “That’s a good thing.”