REAL ESTATE & EQUIPMENT LEASES

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1 ARE FROM JUPITER ARE FROM SATURN 15 DIFFERENCES BETWEEN REAL ESTATE & Developed For:

2 Table Of Contents Real estate versus equipment assets 01 Real estate leases are from Jupiter. Equipment leases are from Mars 02 The similarities and differences 03 Selecting a software vendor 04 1) Size and scale 05 2) Organizational models 06 3) Ownership 07 4) Outsourcing 08 5) Systems 09 6) Rent payment complexity 10 7) Lease structures 11 8) Assets per schedule 12 9) Non-lease components 13 10) Sourcing and initial fees 14 11) Mid-term events 15 12) End of term options 16 13) Past end-of-term 17 14) Complex multi-party transactions 18 15) Lease termination 19 Summary comparison Differences Between Real Estate And Equipment Leases

3 Real Estate Versus Equipment Assets Although, real estate and equipment leases will soon be rolled up together into a single line item on the balance sheet, the assets and the way they are administered are very different. Some of the differences are obvious. Real estate leases are for land or building structures such as corporate offices, distribution centers, manufacturing plants, retail stores, bank branches, data centers, research labs, hotels and casinos. Equipment leases represent a much more diverse category of assets ranging from espresso machines to corporate helicopters. Equipment leases might include IT and data center assets such as servers, laptops and networking gear or fleets of corporate cars, delivery vans and freight trucks. Equipment might also include forklifts and pallet jacks in your warehouses; rail cars and ocean containers in the supply chain; and the photocopiers and furniture at your headquarters. Office Building Factory Plant Vehicle Fleet Corporate Aircraft Distribution Center Bank Branch Material Handling Office Equipment Data Center Hospital Or Lab IT & Data Center Office Furniture 15 Differences Between Real Estate And Equipment Leases PAGE 01

4 Real Estate Leases Are From Jupiter Equipment Leases Are From Saturn The processes, systems and organizations supporting real estate and equipment leases are very different. You would probably never think to have the people that manage your buildings, also manage the delivery trucks in your fleet, the servers in your data center or the forklifts in your warehouse. Nor would you think about using the same database to track the addresses of your buildings and the serial numbers of your laptops. And you probably would not use the same system to track the monthly charges for the corporate jet used by your CEO and the custodial services provided to your factories. You might say that real estate leases are from Mars and equipment leases are from Venus. Or vice versa. To avoid any positive or negative association with either gender (Think Men are from Mars and Women are from Venus), we decided to say that real estate leases are from Jupiter and equipment leases are from Saturn. Everyone knows Jupiter, much like your real estate lease portfolio, is big with lots of gravitational pull. And that Saturn, much like your equipment lease portfolio, is more complex with many different layers (or rings). But the purpose of this guide is not to focus on celestial analogies. Instead, we will focus on the differences and similarities between real estate and equipment leases. Real Estate Leases are From Jupiter Equipment Leases are From Saturn 15 Differences Between Real Estate And Equipment Leases PAGE 02

5 The Similarities And Differences In fact, there are some similarities between real estate and equipment leases. Both have been neglected and under-funded at most organizations. There has been little investment in the people, systems and processes to support real estate and equipment leases. Real estate has gotten more attention over the past decade with centralized organizational models and new technologies such as Integrated Workplace Management Systems. But these new approaches have been limited primarily to large organizations. Equipment leases are not even recognized by most CFOs as a portfolio at most companies. There are also many similarities between the accounting for both real estate and equipment leases. Both can have initial direct costs; fixed or variable rents; and end-of-term options to purchase, extend and terminate. But as you drill down there are some important differences that become important when you are selecting a software vendor for lease accounting. For example, equipment leases often have multiple assets per schedule, whereas real estate leases typically only have one. Equipment Lease rents are based on lease rate factors whereas Real Estate rents are market driven and often based on a utility metric such as cost per square foot. Variable rents (or rents based on a floating rate index) for real estate are often based upon Consumer Price Indices or retail store sales, whereas equipment rents often vary based upon interest rate factors such as Libor, T-Bills or Prime. Real estate lease holders often sub-lease to other tenants. However, sub-leases are rare in the equipment space. SIMILARITIES DIFFERENCES Initial Direct Fees Base & Variable Rents Purchase, Extend & Terminate Assets Per Schedule Sale Leaseback & Sub-Leases Rent Formulas 15 Differences Between Real Estate And Equipment Leases PAGE 03

6 Selecting A Software Vendor Selecting the right application for lease accounting and administration software requires a good understanding of the vendor s true center of gravity. You will need to dig deeper than the marketing materials to understand the historical product strengths of each vendor. For example, you may be surprised to learn that many historically real estate-centric applications do not support the complexities of equipment leases such as asset-level accounting and partial buyouts or returns. Similarly, many historically equipment-centric applications may not offer complex real estate features such as CAMs charges reconciliation; sale/leaseback accounting and sub-lease administration. As you evaluate your lease accounting and administration software needs, it is important to keep in mind the composition of your lease portfolio. Some companies predominantly lease real estate (90% or more of their portfolio) with a handful of other leases. Other companies have more of an even balance (50/50) between real estate and other types of leases such as vehicle fleets; material handling equipment; shipping containers and rail cars; IT and data center equipment. In this guide, we will outline the fifteen key differences between real estate and equipment leases. Armed with the key differences you will be able to better target questions to software vendors. VENDOR A VENDOR B VENDOR C Real Estate Leasing Expertise Equipment Leasing Expertise Lease Administration Features Lease Accounting Features 15 Differences Between Real Estate And Equipment Leases PAGE 04

7 01 Size And Scale In terms of dollar value, real estate lease portfolios tend to be much larger. Although the dollar value of an equipment lease portfolio is smaller, the number of leases and leased assets is typically much higher. A Fortune 500 company might lease 10,000 computers; 2000 vehicles and 500 other types of equipment representing a dollar value of $300M. The same Fortune 500 company, however, might only lease 100 buildings with a lease portfolio value of $1B. Equipment leases also tend to have many more lessors and many more stakeholders within the organization. Many companies will make the mistake of focusing primarily on their real estate lease accounting due to the big dollar values associated with the portfolio, only to find out that equipment leases represent a bigger compliance challenge. Portfolio Value Portfolio Value Number of Leases Number of Leases Number of Lessors Number of Lessors Number of Stakeholders Number of Stakeholders 15 Differences Between Real Estate And Equipment Leases PAGE 05

8 02 Organizational Models Historically, real estate was managed on a decentralized, local basis in each geographic region. For example, each country around the world may have managed facilities locally as part of its procurement or finance organization. But over the past decade there has been a migration towards centralized models for corporate real estate. Equipment leases, however, remain highly de-centralized. Equipment is typically not organized at a geographic level, but rather within different product divisions or business functions. The logistics team manages the shipping containers and rail cars. The IT organization Portfolio manages the laptops, servers, and data center Value leases. And the fleet team manages the cars, trucks and vans. CENTRALIZED DECENTRALIZED 15 Differences Between Real Estate And Equipment Leases PAGE 06

9 03 Ownership In recent years, many large companies have centralized real estate management into a shared services organization. Reporting to the CFO or Chief Procurement Officer, a single global real estate group manages all construction, purchasing, leasing, space planning, maintenance and repair for all facilities worldwide. Equipment leasing, however, has no clear owner at most companies. Treasury, procurement and accounts payable each play a role in the equipment leasing process (as they do with real estate). But due to the diverse range of assets and users across logistics, operations, fleet, IT and other functions, there is not a natural owner. As a result, applying consistent policies, controls and accounting across equipment leases becomes much more challenging than for real estate. IT Logistics Operations Fleet CORPORATE REAL ESTATE MANY DIFFERENT GROUPS 15 Differences Between Real Estate And Equipment Leases PAGE 07

10 04 Outsourcing Many large and mid-size companies have gone beyond centralization of real estate to actually transition day-to-day responsibility for facilities to an outside provider. Firms such as CBRE, Jones Lang LaSalle, Cushman & Wakefield can take over administration of corporate real estate on an outsourced basis providing best practices learned from many different customer experiences. Equipment leasing is rarely, if ever, outsourced. The maintenance, repair and upgrade of certain types of equipment may be bundled as a service component of a lease - especially from vendor captives. But there are no true outsourcing providers that will administer a portfolio of diverse range of IT, fleet, transportation and material handling equipment from many different manufacturers. REAL ESTATE BROKERS WILL PROVIDE FULL-SERVICE OUTSOURCING POINT SERVICES ARE AVAILABLE FROM EQUIPMENT MANUFACTURERS & VARS. 15 Differences Between Real Estate And Equipment Leases PAGE 08

11 05 Systems Most Fortune 500 companies have implemented a centralized real estate administration application. Some companies have invested in a fully-featured Integrated Workplace Management System (IWMS) that manages not only leases, but capital planning, building construction, space planning, facility maintenance and environmental reporting. Whether you are using a Lease Administration application or IWMS, the system should track most of the key terms for real estate leases from expansion clauses and renewal dates to variable rents and CAMs charges. Very few companies, however, have invested in an Equipment Lease Management application. As a result, data about IT, fleet and other equipment leases is scattered across the enterprise. Some data is stored in fleet management and IT asset management applications, while other data is stored in a file cabinet in its original contract form. SINGLE SYSTEM CENTRALIZED REPOSITORY FRAGMENTED NOT INTEGRATED 15 Differences Between Real Estate And Equipment Leases PAGE 09

12 06 Rent Payment Complexity Both real estate and equipment lease contracts employ base and variable rents. Real Estate base rents are typically market based and are structured as a cost per unit (such as square feet). Equipment lease base rents are typically based on a percentage of the original equipment cost. The inputs and calculations used for the variable rents can also be very different. It is common for real estate rent to be adjusted at some regular frequency based upon a market index such as the Consumer Price Index (CPI). In the retail industry, real estate rents are frequently based upon company performance or sales. A chain store in a shopping mall may pay more or less based upon their actual sales at the location. Variable rent for equipment leases is less common. And when utilized, the variable rents are typically based upon an interest rate and/or the usage of the product. For example, vehicle lease rent may vary based upon miles driven. Photocopier rent may be based upon pages. INDEX OR MARKET RATE SALES OR PERFORMANCE USAGE OR CONSUMPTION SALES OR PERFORMANCE 15 Differences Between Real Estate And Equipment Leases PAGE 10

13 07 Lease Structures The types of leases used for commercial real estate are very different than the leases used in IT, fleet and equipment. Common examples of real estate leases include Modified Gross Leases, Triple-Net Leases and Full Service leases. The differences relate to whether landlord costs such as Common Area Maintenance, Insurance and Property taxes are bundled into the lease payment. Common examples of equipment leases include True, Finance, Master, Skip, TRAC, Step-Up, 60 or 90-Day Deferred leases. The differences in equipment lease structures typically relate to payment schedules and the residual value of the asset at the end of term. There are many different equipment purchase options such as Fair Market Value, 10% Put and $1 Buyout. As a result, the accounting challenges for real estate will relate more to unbundling non-service components and identifying re-measurement requirements. For equipment leases, the challenges will relate more to estimating residual values and end-of-term plans. REAL ESTATE LEASES GROSS LEASE DOUBLE NET LEASE TRIPLE NET LEASE EQUIPMENT LEASES SKIP LEASES TRAC SPLIT-TRAC 60 OR 90 DAY DEFERRED LEASE 15 Differences Between Real Estate And Equipment Leases PAGE 11

14 08 Assets Per Schedule Real estate leases typically have one building, or asset, per lease schedule. However, it is common for equipment leases to have multiple assets per schedule. You don t negotiate a separate lease for each laptop or truck or piece of furniture that you lease. One lease might have one hundred laptops or fifty office chairs bundled onto a single schedule. The number of assets per schedule becomes much more relevant with the new lease accounting standards. Leases must be managed not as monolithic contracts, but as if every asset (every piece of equipment) is a lease. However, software applications designed to manage real estate leases are not capable of asset-level debits and credits. SINGLE SCHEDULE SINGLE ASSET SINGLE SCHEDULE MULTIPLE ASSETS 15 Differences Between Real Estate And Equipment Leases PAGE 12

15 09 Non-Lease Components The new lease accounting standards require separation of lease from non-leased components. The types of non-lease components bundled into real estate and equipment leases vary significantly. As a result, the analysis to perform the accounting will focus on different components for real estate than equipment. Many real estate landlords pass along costs for property taxes and insurance in their rent payments. Net leases also include Common Area Maintenance (CAMs) charges for expenses shared across tenants. Examples of CAMs charges might include utilities, parking, landscaping, artwork, snow removal and trash collection services. Equipment lessors will sometimes bundle in software, training, maintenance, repair and professional services into leasing contracts. Additionally, some equipment leases include contracts for re-supply of materials. Think toner ink and paper for photocopiers. TAX PROPERTY TAXES MAINTENANCE & REPAIR COMMON AREA MAINTENANCE SERVICES SOFTWARE LICENSES PROPERTY INSURANCE RE-SUPPLY CONTRACTS 15 Differences Between Real Estate And Equipment Leases PAGE 13

16 10 Sourcing And Initial Fees Commercial real estate properties are typically selected with the help of a specialized broker. Although a company may compare multiple different properties there is only one potential landlord (lessor) for any specific asset to be leased. Similar, companies may compare many different makes and models of equipment to fulfill a specific business need. However, unlike with real estate, there are hundreds, if not thousands, of potential lessors to provide the financing. Equipment leases can be put out to a competitive bid between commercial banks, vendor captives and independent lessors. The upfront fees collected with real estate leases are often very different than with equipment. Real estate leases involve broker commissions and security deposits as well as concessions such as free rent periods and tenant improvement allowances. Equipment leases might include fees for installation, shipping and services. COMMERCIAL BANKS INDEPENDENT LESSORS SINGLE LESSOR VENDOR CAPTIVES 15 Differences Between Real Estate And Equipment Leases PAGE 14

17 11 Mid-Term Events Real estate leases tend to be for longer terms (e.g. 10 years) than equipment leases (e.g. 3-5 years). However, real estate leases typically have far fewer changes during the term of the lease than equipment. With real estate leases not only may the pricing change (as discussed in #5), but the tenant may have an option to expand or contract the amount of floor space at certain milestones in the lease. Additionally, many real estate leases offer the tenant the option to sublet or reassign a portion of the space to another tenant. Equipment leases undergo a different set of events. Assets such as forklifts and trucks may change locations several times during a lease. Computers and office equipment may be reassigned to different cost centers. Partial buyouts of equipment mid-term can occur if asset(s) are lost, stolen or damaged. Partial returns can also occur, in which some equipment is kept on lease, but other assets are returned to the manufacturer/lessor. REAL ESTATE LEASES TENANT IMPROVEMENT OPTION TO EXPAND FIRST RIGHT OF REFUSAL EQUIPMENT LEASES LOCATION CHANGE PARTIAL RETURN PARTIAL BUYOUT 15 Differences Between Real Estate And Equipment Leases PAGE 15

18 12 End-of-Term Options At the end of a real estate lease, the tenant typically has the option to extend or terminate the lease. Additionally, a tenant may elect to renew while expanding or contracting the amount of space on the lease. At the end of term for an equipment lease typically one of three scenarios occurs. First, the lease may be terminated in which case the equipment is returned. Second, the lease may be extended, typically at a lower rent and different residual value. Third, the equipment on the lease may be purchased and ownership transferred from the lessor to the lessee. In many equipment leases, two or all three of the scenarios can occur. Equipment leases have multiple assets per schedule. Some of the assets may be renewed while others are purchased or returned. These partial buyouts, partial renewals and partial returns have a much higher level of accounting complexity. TERMINATE RETURN RENEW RENEW EXPAND BUYOUT 15 Differences Between Real Estate And Equipment Leases PAGE 16

19 13 Past End-of-Term With equipment leases, it is quite common for no action to be taken at the end of term. The lease moves into an evergreen period. The lessee can continue to use the equipment assets indefinitely as long as they continue to make the regularly scheduled rent payments. Most Fortune 500 companies have 20% or more of their equipment leases in evergreen for periods of six months or longer. Paying evergreen fees past the end-of-term erodes the economic benefit of leasing equipment. However, most companies do not track these losses so they are unaware of the issue. When real estate leases extend past end-of-term there is a more punitive fee assessed. Holdover penalties range from % of the original rent providing an incentive for tenants to decide on whether to renew, terminate or expand/contract. Holdover Penalties Evergreen Fees End of Term End of Term 15 Differences Between Real Estate And Equipment Leases PAGE 17

20 14 Complex Multi-Party Transactions Complex arrangements such as sub-leases and sale/leaseback transactions are common with real estate leases. Real estate sub-leases occur when the tenant sublets part, or all, of a leased property to another tenant. In these scenarios, the tenant effectively becomes a landlord responsible for collecting monthly rent inclusive of variable CAMs charges. Not only does the tenant become a landlord, but they act as a lessor from an accounting standpoint. Equipment is rarely, if ever, sub-leased or sold to a lessor. And therefore many of the more complex accounting scenarios are not relevant to equipment leases. SALE/LEASEBACK REAL ESTATE EQUIPMENT COMMON RARE SUB-LEASE COMMON RARE 15 Differences Between Real Estate And Equipment Leases PAGE 18

21 15 Lease Termination At the end of a real estate lease, the landlord is obligated to return the security deposit after the tenant vacates the premises. However, the tenant may be assessed surcharges if they fail to remove trade fixtures; personal property; telephone wiring; debris and rubbish. The issues and fees associated with the end of an equipment lease are different. The equipment needs to be packaged and shipped back to the leasing company. Additional surcharges may be assessed if the equipment experienced excessive wear and tear; exceeded mileage limits or lacks packaging and documentation. Trade Fixtures Excess Use Personal Property Documentation Debris Packaging 15 Differences Between Real Estate And Equipment Leases PAGE 19

22 Summary Comparison ISSUE REAL ESTATE LEASES EQUIPMENT LEASES Portfolio Value Large Dollar Small Dollar Number of Leases 10s-100s 100s-1000s Number of Lessors 10s-100s 10s-100s Number of Stakeholders 10s 100s-1000s Organizational Model Centralized De-Centralized Ownership Corporate Real Estate No Clear Owner Outsourcing Common Rare Systems Real Estate Lease Admin No System of Record Rent Payments CPI or Sales Usage or Performance 15 Differences Between Real Estate And Equipment Leases PAGE 20

23 Summary Comparison ISSUE REAL ESTATE LEASES EQUIPMENT LEASES Lease Structures Gross, Triple Net Skip, TRAC, Deferred Assets per Schedule Non-Lease Components 1:1 Asset/Schedule Tax, Insurance, CAMs N:1 Asset/Schedule Maintenance; Re-Supply Sourcing Mid-Term Events End-of-Term Events Past End-of-Term Sale/Leaseback Sub-Leases Single Lessor Expand; Tenant Improvement Terminate, Renew, Expand Holdover Penalties Common Common Many Lessor Options Partial Buyout or Return Return, Renew, Buyout Evergreen Fees Rare Rare 15 Differences Between Real Estate And Equipment Leases PAGE 21

24 LeaseAccelerator offers the market-leading SaaS solution for Enterprise Lease Accounting, enabling compliance with current and new FASB and IFRS standards. Using LeaseAccelerator s proprietary asset-based Global Lease Accounting Engine, customers can account for all categories of leases including real estate, fleet, IT, material handling and other equipment at an asset-level. On average, LeaseAccelerator s lease Sourcing and Management applications generate savings of 17% on equipment leasing costs with smarter procurement and end-of-term management.