Quick Guide - Financial Impact of Real Estate Transactions

1. Ploutus Advisors
A real estate advisory firm based in Los Angeles California
Quick Guide – Financial Impact of
Real Estate
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2. What Ploutus Advisors Offers
Unbiased Conflict-Free Advisory
Personalized Commercial and
Corporate Real Estate Consulting
Experienced Real Estate
Investment Advisory
Dependable assistance to Public
and Private Organizations,
Tenants, Landlords and Investors
Trust and Transparency
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E – Entrepreneurial, Efficient,
Effective Helping clients look beyond
the obvious
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3. Reference Material
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4. Classification of Lease
Lease Capitalization
Decision
Yes
Does lease transfer ownership to
Transfer of Ownership lessee by the end of lease term?
No
Yes
Bargain Purchase Option Does lease contain a bargain
purchase option?
No
Yes
Does Lease begin in the last
25% of the asset’s
estimated life?
No
Yes Is length of lease term 75% or
75% of life test met? more of the asset’s useful life?
No
Yes
Is present value of lease 90% or
90% of fair value test met? more of fair value of property,
No less any investment tax credit
retained by lessor?
Capital Lease ** Operating Lease
** Lessor must determine that 2 additional criteria are met to account for the lease as a capital lease: (i) collection of
minimum lease payments is reasonably predictable; and (ii) no important uncertainties exist for unreimbursable costs to
be incurred by the lessor.
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5. Lease vs. Own
Lease Own
(i) Limits investment in real (i) Requires investment in
estate real estate
(ii) Greater flexibility to move (ii) Lesser flexibility to move
(iii) Invest equity in other (iii) Use some equity-debt
opportunities combo
(iv) Lesser investment risk, but (iv) Greater investment risk,
potential rent escalations but potential tax benefits
(v) Lesser control (v) Greater control
Evaluate mission, funding sources and real estate markets – if the
return based on incremental cash flows and other benefits are
not sufficient to warrant risk associated with ownership, lease
rather than own
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6. Recent and Proposed Changes
INDUSTRY GOAL
Better Transparency and Compliance Standards
Mark-to-Market Valuation No Off-Balance Sheet
Treatment of Operating
Leases
SFAS – 157, “Fair Value Measurements”
Effective for Real Estate as of Nov, 15, 2008 May become effective by 2011
RESULT
Massive Impact on Financial Statements
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7. Mark-to-Market
SFAS – 157, “Fair Value Measurements”
Effective for Real Estate as of Nov, 15, 2008
Scenario 1 Scenario 2
Acquisition Cost $50,000,000 $50,000,000
Year of Acquisition 1990 2005
Depreciation Period 39 Years 39 Years
Accumulated Depreciation $25,641,026 $6,410,256
Net Book Value $24,358,974 $43,589,744
Deterioration of Value 25.0% 25.0%
Current Market Value $37,500,000 $37,500,000
Mark-to-Market Impairment $0 ($6,089,744)
Write-Down and Impact on Pre-Tax Profit $0 ($6,089,744)
Balance Sheet Profit
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8. Capital Lease vs. Operating Lease
Scenario 1 Scenario 2
Annual Rent $50,000 $50,000
Lease Term (Years) 10 5
Number of Lease Renewals 1 2
Borrowing Rate 8.00% 8.00%
Operating Lease
Asset Impact (Balance Sheet) None None
Liability Impact (Balance Sheet) None None
Annual Expense (Income Statement) ($50,000) ($50,000)
Capital Lease
Asset Impact (Balance Sheet) May become $343,423 $205,493
effective by 2011
Liability Impact (Balance Sheet) $343,423 $205,493
Annual Depreciation (Income Statement) ($34,342) ($41,099)
Annual Interest (Income Statement) ($26,629) ($15,181)
Annual Expense (Income Statement) ($60,972) ($56,280)
Following Year:
Asset Impact (Balance Sheet) $309,081 $164,395
Liability Impact (Balance Sheet) $320,052 $170,675
Annual Depreciation (Income Statement) ($34,342) ($41,099)
Annual Interest (Income Statement) ($24,689) ($12,291)
Annual Expense (Income Statement) ($59,032) ($53,390)
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9. Impact of Changes
Capitalization of
Mark-to-Market Operating Leases
Earnings
Debt covenant ratios
Capital requirements
Credit ratings
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10. Financial and Reporting Impact
Transaction Cash Balance Sheet ROA Income Statement Loan
Structures Asset Liability EBITDA NI Covenant
1 Conventional
Operating
Lease
2 Capital Lease
3 Ownership
Generally Positive Impact
Generally Negative Impact
Impact Uncertain
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