As the COVID-19 pandemic continues and businesses make strategic changes in response, one of the primary areas of focus is managing where employees will work and evaluating real estate portfolios.
In a recent survey conducted by Deloitte, 66.9 percent of 7,700 respondents indicated they have launched a program or plan to initiate a study to look at how they use real estate in the post-pandemic world.
The results of the poll showed real estate rationalization can take a number or forms. Of the above-mentioned group, plans include the following:
- Reducing real estate footprint by eliminating owned and leased space (43.1 percent).
- Rightsizing by reducing space in certain parts of the business while expanding space used in others (33.1 percent).
- Expanding real estate footprint by purchasing or leasing additional space (16.4 percent).
- Initiating sale/leaseback transactions (7.4 percent).
Business as usual
“While the pandemic may have accelerated some of these changes, due to the ever-evolving business models at many organizations, companies are always looking at the best way to adapt and operate efficiently, including reevaluating their real estate footprints,” said Tim Kolber, managing director, audit and assurance and leases leader at Deloitte.
The goal of a real estate rationalization program in the current environment is to rightsize real estate portfolios to support changing business needs, including employees working remotely or semi-virtually. Cost containment may be a desired outcome. Some businesses are reducing their real estate footprint by modifying lease agreements and exiting space before their leases end. Others are executing sale-leaseback transactions to sell owned real estate they no longer need, which provides cash flow during the leaseback period to improve liquidity or finance other business strategies.
There are also companies leasing or buying new real estate, or modifying existing leases, to add/reconfigure space to accommodate changes in how people work or how the business is operating or expanding. This includes more hoteling and conference room areas, adding space for social distancing requirements, and changing geographic locations.
“A lot of these decisions may have been made prior to the economic environment changing the last couple of years, and companies are now just pulling the trigger and executing those plans,” Kolber said.
Matt Hurley, senior manager at Deloitte Advisory, concurred. He and Kolber are contributing authors to Deloitte’s publication, “Reevaluating your real estate footprint.”
“There were already changing technologies and demands in the workforce creating a need to tap into employee skills not just in the local area but also out of state. COVID-19 accelerated this,” Hurley said. “Increased use of the cloud, along with collaboration and video conferencing tools, allowed organizations to challenge the best structure of work, to recognize that people can work from anywhere, and to successfully move to virtual work environments.”
Pandemic provides a push
“COVID-19 accelerated the overarching premise companies were grappling with before the pandemic: how to leverage technology and improve functionality to reduce costs,” said Rich Mirliss, managing member and consulting practice leader at Consilium Partners, an affiliate of CohnReznick.
Improvements in technology have enabled companies to make changes in their real estate footprints that would not have been possible otherwise. These include where data centers and information technology people are located, access and reliability changes, outsourcing, and use of collaboration software.
Mirliss noted although use of the cloud had been around long before COVID-19, the pandemic made people rethink their operations and whether there was a better way. “COVID highlighted the cloud’s importance from a risk, outsourcing, and scalability perspective,” he said. “Organizations can be geared up even if they are not on the premises.”
“There was a runway to COVID-19 where real estate and technology were coming together,” said Steve Pavon, managing member at Consilium Partners. “In March last year, when offices started shutting down and everyone had to work remotely, it was just a matter of time before businesses started to see if the cloud and other technologies they had invested in were actually going to work.”
There were two camps, Mirliss said: One on the fence pre-COVID about changing their operations to a hybrid-work strategy that used the pandemic as an excuse to do it, and the other being more hesitant, waiting and holding off to make permanent change.
“When vaccines started to be administered in March and April of 2021, they thought they might return to their offices by the fall,” he said of the second group. “Then the Delta variant came, and there was less certainty about returning to the office. That second camp started to realize maybe it was a more fluid situation and time to start thinking about their space needs and coming up with a plan.”
Real estate rationalization decisions are both organization- and industry-dependent.
Companies should consider using consultants to help them come up with a plan that incorporates their business strategy, technology, products, customers, and regulatory and compliance issues.
“When we work with a large organization, we start with the CFO and then meet with every department head to complete a detailed questionnaire that defines all the issues for each department,” Pavon said. “We help them understand the totality of all the impacts, and then formulate a plan for each location in the real estate portfolio: reduce space, sell, renovate, consolidate, or relocate.”
What are the accounting implications?
Different types of real estate rationalization strategies have different accounting outcomes. Rationalization programs that change how assets are used might change a company’s identified asset groups or lease components. These have a direct impact on the accounting.
“Applying the guidance in ASC 842 (Leases) is brand new to U.S. GAAP, so it is important to understand application of the guidance and the accounting consequences of rationalization decisions,” said Kolber, who cited the following pressure points:
- How and to what extent do I apply the ASC 360 impairment model to a right-of-use asset?
- When does abandonment accounting come into play?
- How do I apply the modification framework in ASC 842?
“Everyone seems to have the mindset that if you have a lease of a building with multiple potential components, you apply the accounting to the one lease component you are changing,” he said. “But there is generally a higher level the requirements are applied at because that one lease component is linked to other components, and all are impacted by the change.”
“We have seen organizations approached by real estate companies with new and creative ideas,” Hurley said. “Fortunately, some of their operations people got accounting and finance involved in scenario analysis and what it meant to the financial statements. Once the organization understood the accounting and tax implications, they realized they did not have as strong a position to take as they thought.”
CFOs need to be aware of how to apply the accounting requirements to potential real estate rationalization plans and get advisors involved before executing initiatives to make sure transactions are structured in a way that meets the company’s desired accounting outcomes.