As a company weighs its options between signing a short-term and a long-term commercial lease, there are many things it must consider.

“Organizations need to weigh the benefits of locking in historically low lease rates long-term (seven to 10 years) or having the flexibility of a short-term lease,” says Steve Kim, a senior associate, Transaction Management, with Plante Moran CRESA. “Each comes with benefits and risks.”

Low real estate costs can help increase your competitive advantage. However, there are potential downsides to entering into a longer contract that need to be realized and hedged against to create maximum flexibility for your company.

Smart Business spoke with Kim about lease terms and how to negotiate the right conditions to suit your business needs, both today and in the future.

What crucial areas should a lessee consider when choosing real estate for a long-term lease? 

When considering a long-term lease, a business should first determine whether the real estate is aligned with its strategic business plan. For example, does the space have room to accommodate your long-term growth plans? Does the building fit with your company’s image and brand? Conducting a space program is essential versus adding a percentage to your current square footage. This exercise will categorize and assign a square footage to all of your space, including conference rooms, executive offices, staff work spaces, common areas and storage, as well as account for future growth.

In addition, with building values at historic lows, purchasing real estate may be a viable option to consider, giving you the ability to lease out space until you need it.

What conditions would signal to a business whether a short- or long-term commercial lease is a more favorable option for a business?

Short-term leases offer a company the most flexibility, but they do have a downside. Lessees often don’t have as much room to negotiate terms and conditions in a short-term agreement as they do in a longer-term one. Also, landlords know all too well the cost of moving a business and could raise your rent at renewal, betting that you will not want to relocate. In addition to potential rate increases, there is no guarantee that you will be able to renew a short-term lease, especially if a large or long-term tenant needs your space.

Long-term leases will typically offer higher tenant improvement allowances, while short-term leases may require out-of-pocket costs by the tenant. But long-term leases also carry risks. Business conditions may change while you are locked into a long-term agreement, making it difficult to expand or contract your business based on a change in your strategic direction. However, an early termination option can be negotiated into a long-term lease to offer some flexibility while maintaining the security and extended savings.

What is an early termination option?

An early termination option allows you to opt out of your lease at a certain point in the contract, which reduces some of the risks that can come with being locked into a long-term agreement. It also offers an opportunity to renegotiate with your landlord midway through your agreement.

A company could work out an option to extend a short-term lease to hedge against losing the space or being hit with a rent increase, but the protections are not guaranteed, as those that accompany a long-term agreement would be.

When trying to negotiate a termination right in a lease, it is helpful to understand the landlord’s potential challenges in providing this option. The situation varies from building to building in regard to ownership structure and the debt situation, for example, and investigating these facts prior to the request is mission critical. Furthermore, the ability to terminate a lease may also be less advantageous if the termination fee is equaled to an amount that is perceivably unlikely to be paid.

Termination option fees requested by landlords are typically for the unamortized portion of the costs based on the market value of the transaction made when the lease was signed, along with an interest rate factor and a penalty equal to the value of rent for a few months. However, if the landlord receives adequate notice that a tenant is leaving, it should allow that tenant to lease the space and head off any loss of income. Termination fees require time to negotiate and ultimately should reward the landlord for offering additional concessions in exchange for extending the term.

What else can a company do to mitigate risk and reduce costs in a lease situation?

Another option to consider is subleasing, which can help a company recoup a portion of its rental expenses. However, expect to invest time and money on the front end to find a tenant and adapt the space.

If the necessary tenant improvements are financially viable for a company to pay upfront, the landlord has a greater ability to accept the termination option because the initial investment in the transaction has been reduced. Furthermore, a lease rate associated with an ‘as-is’ deal is usually below market and can protect tenants with renewal options going forward. Finally, some of the tenant improvements may be depreciated, ultimately lowering some of the company’s potential tax

liability for a given year.

Steve Kim is a senior associate, Transaction Management, with Plante Moran CRESA. Reach him at (248) 223-3494 or steve.kim@plantemoran.com.

Insights Real Estate is brought to you by Plante Moran CRESA

Published in Detroit

Capital projects require a great deal of attention in order to be successfully completed. There are many pitfalls and each can be costly or potentially derail the project. That’s where owner’s representatives come in.

“From the perspective of CEOs and CFOs, hiring an owner’s representative to manage a capital project serves to eliminate uncertainties by engaging experienced leadership. The result of that is to increase the predictability of the outcome of the project,” says Ken Mason, CPC, vice president of Plante Moran CRESA.

Owner’s representatives manage projects from concept through completion. They understand what questions to ask, what information needs to be gathered, and how to keep projects on time and on budget.

“We have the ability to develop very accurate cost models so boards and CEOs can make informed decisions before they set a project in motion, otherwise they might plan for months only to find out a project is not feasible,” he says.

Smart Business spoke with Mason about the role of an owner’s representative and how they help ensure projects are completed as originally intended.

What aspects of a capital project does an owner’s representative handle?

It starts with the strategic planning and project feasibility. An experienced owner’s representative or project manager can help develop the right business model and collect outside data, such as a develop demand analysis, and perform demographic and market research, to help create the financial architecture of the project and understand its purpose. The owner’s representative also develops schedules and budgets that are both reasonable and attainable.

In the schedule, there are components beyond physical construction activities, such as regulatory requirements, entitlement time frames, move planning and other milestones.

Owner’s representatives also handle the team selection process, which is criteria based, to make sure you’ve got the right designers and construction firms. Part of that process is working for tough, but fair, contract language that appropriately transfers the risk to those various entities, thus mitigating the owner’s risk.

A strong owner’s representative is vigilant in the budget and schedule management and oversight. Also, through the use of technology, he or she should offer real-time reporting and access to information at the click of a button to help owners understand the key indicators of the project.

Additionally, through the process there’s always a need to have the project owner’s internal resources engaged in the projects. Experienced owner’s representatives know when to engage these people and when not to, in order to keep staff on their mission and not engage them unnecessarily throughout the process.

It’s important to bring a strong end to the project, including financial and closeout activities with diligent oversight. Move management is also an important activity that needs to be managed to not disrupt operations.

What background do owner’s representatives typically have?

Usually there is blended experience within a team. Someone may have more experience on the project design and planning side or on the physical construction and technical building side. That’s typically supplemented with some financial experience and understanding of how to look at a business plan and make sure that the goals are obtainable and the assumptions made are correct. You have to have a little experience in a lot of things and understand when you need outside resources to support you for the occasional deeper dives required throughout the project’s life cycle.

Typically one owner’s representative serves as a project’s lead, but he or she is supported by a multidisciplinary team of experts who  are involved at the appropriate time.

Why should an owner’s representative be brought on to a capital project?

Organizations may not have the resources to handle all the tasks of a large construction project. There are numerous risks associated with any project, such as not meeting financial expectations, running late or over budget, or having mistakes made along the way that add costs. Permitting and regulatory requirements are also part of the day-to-day responsibilities of the project manager.

A lot of projects could fail because you had the right business plan and budget, but the wrong team. Some people who have never been through the process might not know how to gather and analyze the appropriate data to select one. You could have good intentions at the outset, but the wrong expertise. It’s not always a cost-based selection, it’s really criteria based, which involves costs, experience and the team that’s put in place.

One client, for example, had started a major capital project on its own. About a third of the way through it asked Plante Moran CRESA to look at where it was and perform an analysis. We found the project was behind schedule and significantly over budget. We developed a recommendation and recovery plan, and then implemented it. The project was completed in the originally defined time frame and for less than their original budget.

Why should an owner’s representative work through the completion of the project?

At the end of a project, without some oversight, there’s a tendency for things to linger — a few open issues don’t get addressed properly, paperwork and lien exposure is not adequately mitigated, financial closeout doesn’t happen on the appropriate timeline. The longer these stay open, the greater the financial risk and the more obstacles exist to meeting the original expectations.

Also, when you’re moving into a new facility it’s a major undertaking with a lot of pieces and parts that need to be planned for, and events need to occur in a timely and orderly fashion to not disrupt business operation.

Ken Mason, CPC, is vice president of Plante Moran CRESA. Reach him at (248) 603-5236 or ken.mason@plantemoran.com.

Insights Real Estate is brought to you by Plante Moran CRESA

Published in Detroit

People are approaching how they use office space differently than they have in the past, says Ronald J. Gantner, CPA, a partner with Plante Moran CRESA. And this has changed how buildings are designed and renovated.

‘The generation coming up in the work force wants more collaborative space, with fewer walls and greater technology infrastructure,” says Gantner. “Some buildings and landlords have adapted, some have yet to catch up, and others may not be able to create the environment today’s tenants are demanding.”

Finding the right building for your needs and determining which is the most affordable — and that is not necessarily the one with the lowest rent — can be challenging and time consuming. But you don’t have to go it alone. An experienced tenant representative can assist you through the process.

Smart Business spoke with Gantner about tenant representatives and how they can help you navigate the real estate market while you stay focused on your business.

How have the changing needs of businesses affected office real estate?

In the real estate business, we used to talk about price per square foot. Now buyers are looking at the cost per person or the occupancy cost per employee. This creates an opportunity to accommodate more people within more flexible spaces and reduces tenants’ demand for square footage. We’re seeing more maximization of space or greater efficiency in the way space is used, which will drive down cost.

From a landlord’s perspective, buildings need to adapt and be smarter to recapture rent. A significant cost of space build out is related to the technology that our new wireless, high-tech workers demand. Existing buildings with a strong technology backbone are going to command a higher rent as this offsets improvements that would need to be made to bring another space up to par. More flexible and collaborative space will create a higher demand. Everything from WiFi in common areas and cafeterias to flexible space with lots of parking sets the best buildings apart.

Some market areas don’t have a lot of quality buildings that can be easily retrofitted to accommodate what today’s tenants are looking for. Tenants may discover the list of great opportunities is shorter than the recent high vacancy rates may imply. Rent is only one component of your total occupancy costs. Ultimately, tenants don’t want to put much capital into a nonperforming asset. Instead, they want to invest it into their core business because it will result in a higher rate of return.

How can a tenant representative help?

A tenant representative is an advocate for the tenant. Often tenants can get hung up on a great real estate deal and fail to analyze whether it is a good business deal. A representative will show you all of the options that make sense to your business from a real estate, financial and strategic perspective. It might seem attractive to only pay $15 per square foot for the real estate, but it could cost $100 per square foot to upgrade the space to work for the client. They look at aspects beyond rent, including the cost to move and build out a space, as well as the surrounding amenities to present you with the top options based on your needs and budget.

How important is the tenant representative’s ability to be independent?

It is extremely important to work with someone who is not incentivized by a landlord to lead you in a particular direction. Using an independent tenant representative will avoid conflicts of interest and show you all the options that make sense for your business. Having an advocate sitting only in your corner is also valuable in negotiation.

What are the dangers of conducting the search for office space on your own?

Tenant representatives are involved in numerous transactions on a daily basis. They have extensive knowledge about the market and what to look for in a real estate contract, and even help ensure your lease has flexibility for expansion or contraction. Tenant representatives have learned best practices over hundreds of transactions and years of experience, while comparatively, most business owners will be learning as they go while deflecting efforts away from their business’s core functions. And if you make a mistake, it can be very costly for a long time to come.

Can working with a tenant representative lead to a better deal?

Absolutely. Tenant representatives know the market, the transactions that are happening and what capital dollars landlords are spending to entice tenants. They also know the capital structure of the landlords who own the building you’re considering.

In the past years of the economic downturn, landlords have lost buildings or remain troubled financially. Tenant representatives can educate the client on these situations, which may range from a decline of property maintenance services or even foreclosure.

Once you are into a building and the property and facilities are not tended to properly, it impacts a company’s ability to do business. So it is not only pricing, it is making sure you are in a suitable location where you can conduct your business relatively worry free.

How do you select a tenant representative?

The important thing is to begin the process early — at least two and a half years before your lease expires. Also, talk to two or three providers. Look for firms that have independence or that work only on behalf of tenants. Talk with them about their process, look at their financial capabilities and work to understand the P&L impact of these real estate transactions. You want a firm that can handle your space planning needs while working to get the best pricing for the property.

 

 

Ronald J. Gantner, CPA, is a partner with Plante Moran CRESA. Reach him at (248) 603-5257 or ron.gantner@plantemoran.com.

Insights Real Estate is brought to you by Plante Moran CRESA

Published in Detroit

As a company weighs its options between signing a short-term and a long-term commercial lease, there are many things it must consider.

“Organizations need to weigh the benefits of locking in historically low lease rates long-term (seven to 10 years) or having the flexibility of a short-term lease,” says Steve Kim, a senior associate, Transaction Management, with Plante Moran CRESA. “Each comes with benefits and risks.”

Low real estate costs can help increase your competitive advantage. However, there are potential downsides to entering into a longer contract that need to be realized and hedged against to create maximum flexibility for your company.

Smart Business spoke with Kim about lease terms and how to negotiate the right conditions to suit your business needs, both today and in the future.

What crucial areas should a lessee consider when choosing real estate for a long-term lease?

When considering a long-term lease, a business should first determine whether the real estate is aligned with its strategic business plan. For example, does the space have room to accommodate your long-term growth plans? Does the building fit with your company’s image and brand? Conducting a space program is essential versus adding a percentage to your current square footage. This exercise will categorize and assign a square footage to all of your space, including conference rooms, executive offices, staff work spaces, common areas and storage, as well as account for future growth.

In addition, with building values at historic lows, purchasing real estate may be a viable option to consider, giving you the ability to lease out space until you need it.

What conditions would signal to a business whether a short- or long-term commercial lease is a more favorable option for a business?

Short-term leases offer a company the most flexibility, but they do have a downside. Lessees often don’t have as much room to negotiate terms and conditions in a short-term agreement as they do in a longer-term one. Also, landlords know all too well the cost of moving a business and could raise your rent at renewal, betting that you will not want to relocate. In addition to potential rate increases, there is no guarantee that you will be able to renew a short-term lease, especially if a large or long-term tenant needs your space.

Long-term leases will typically offer higher tenant improvement allowances, while short-term leases may require out-of-pocket costs by the tenant. But long-term leases also carry risks. Business conditions may change while you are locked into a long-term agreement, making it difficult to expand or contract your business based on a change in your strategic direction. However, an early termination option can be negotiated into a long-term lease to offer some flexibility while maintaining the security and extended savings.

What is an early termination option?

An early termination option allows you to opt out of your lease at a certain point in the contract, which reduces some of the risks that can come with being locked into a long-term agreement. It also offers an opportunity to renegotiate with your landlord midway through your agreement.

A company could work out an option to extend a short-term lease to hedge against losing the space or being hit with a rent increase, but the protections are not guaranteed, as those that accompany a long-term agreement would be.

When trying to negotiate a termination right in a lease, it is helpful to understand the landlord’s potential challenges in providing this option. The situation varies from building to building in regard to ownership structure and the debt situation, for example, and investigating these facts prior to the request is mission critical. Furthermore, the ability to terminate a lease may also be less advantageous if the termination fee is equaled to an amount that is perceivably unlikely to be paid.

Termination option fees requested by landlords are typically for the unamortized portion of the costs based on the market value of the transaction made when the lease was signed, along with an interest rate factor and a penalty equal to the value of rent for a few months. However, if the landlord receives adequate notice that a tenant is leaving, it should allow that tenant to lease the space and head off any loss of income. Termination fees require time to negotiate and ultimately should reward the landlord for offering additional concessions in exchange for extending the term.

What else can a company do to mitigate risk and reduce costs in a lease situation?

Another option to consider is subleasing, which can help a company recoup a portion of its rental expenses. However, expect to invest time and money on the front end to find a tenant and adapt the space.

If the necessary tenant improvements are financially viable for a company to pay upfront, the landlord has a greater ability to accept the termination option because the initial investment in the transaction has been reduced. Furthermore, a lease rate associated with an ‘as-is’ deal is usually below market and can protect tenants with renewal options going forward. Finally, some of the tenant improvements may be depreciated, ultimately lowering some of the company’s potential tax liability for a given year.

Steve Kim is a senior associate, Transaction Management, with Plante Moran CRESA. Reach him at (248) 223-3494 or steve.kim@plantemoran.com.

Insights Real Estate is brought to you by Plante Moran CRESA

Published in Detroit

In a typical commercial real estate transaction, the seller is taxed on any gain realized from the sale of his or her property. However, there are mechanisms available by which the tax liability associated with these gains on sale can be deferred by reinvesting the sale proceeds into another property through a 1031 like-kind exchange. Section 1031 of the Internal Revenue Code provides that no gain or loss shall be recognized on the exchange of property held for use in a business or for investment.

Smart Business spoke with Greg VanKirk, CPA, partner with Plante Moran CRESA, about the benefits and guidelines of exchanging property under 1031 exchange rules and how it compares to a typical real estate sale.

What are the benefits of a 1031 exchange?

The primary reason for a property or business owner to execute a 1031 exchange is to defer taxes on gains incurred on the sale of a property. In essence, you are able to redeploy capital into investments that are greater in scale, more diverse or more aligned with your business or investment strategy. An example that illustrates this could be exchanging a parcel of vacant land for an income-producing property while deferring the tax liability incurred from the original sale.

Regardless of how you reallocate your portfolio within the IRS guidelines, the 1031 exchange strategy allows you more to reinvest at a time when real estate prices are at historic lows. Even if the property or building you are selling is depressed, deferring depreciation recapture is part of the equation.

At this time the long-term capital gains tax rate for individuals is 15 percent for at least the remainder of 2012. If this rate were to rise to 20 percent, as many are currently projecting, more businesses would be expected to take advantage of 1031 exchanges and then wait until a time period when the rate is lower to realize gains.

What are the regulations of a 1031 exchange?

There are some strict rules and guidelines that determine what constitutes a valid exchange. The first stipulates the exchange must be between qualifying properties of like-kind. Most real estate, held for use in the trade of business or for investment, will qualify with the exception that they must both be within the borders of the U.S. Some personal property can also qualify for an exchange, but is not like-kind to real estate. Property that specifically would not be considered qualified includes inventory or stock in trade; stocks, bonds, or notes; other securities or debt; partnership interests; and certificates of trust.

Timing is another significant guideline that cannot be extended for any hardship or circumstance short of a presidentially declared natural disaster. There is a 180-day window during which the seller involved in the transaction must search, identify and close on the purchase of the new property in order for the 1031 exchange to be valid. While more than one property may be identified initially, the property being purchased must be identified as part of the exchange no more than 45 days from the time the seller’s property is relinquished and closing on the new property must be complete within 180 days of the transfer.

The total purchase price of the property to be acquired must be equal to or greater than the total net sales price of the property being relinquished and all of the equity received from the transaction must be used to acquire the property targeted in the 1031 exchange. If the replacement property purchase price is less than the relinquished property, a tax will be applied to the difference. Another fundamental rule requires that the net equity in the replacement property must be equal or greater than the net equity in the property sold, or the purchaser will be required to pay the tax on the amount of decrease.

Finally, the sale must also go through a qualified intermediary— simply selling the building or property and using the proceeds to purchase another disqualifies the exchange. These intermediaries are companies that work full time facilitating such exchanges. A qualified intermediary needs to be an independent organization that will handle the funds from the original sale through the exchange process and then deliver the money to the closing agent. The intermediary will also be responsible for filling out all of the appropriate tax forms  and exchange agreements related to the process.

Does the current real estate market favor an exchange?

Every situation is different and an unbiased real estate professional can lay out all of your options to help you determine if a 1031 like-kind exchange is a feasible option. Owners selling their business may want to consider offsetting any gains on real estate by purchasing an income-producing property.

Depressed real estate values on one hand offer appreciation opportunity, while on the other hand limit the amount of quality real estate available for exchange. If the capital gains tax rate increases, experts would expect the amount of like-kind exchanges would increase.

Greg VanKirk, CPA, is a partner at Plante Moran CRESA. Reach him (248) 223-3395 or greg.vankirk@plantemoran.com or visit www.pmcresa.com.

Insights Real Estate is brought to you by Plante Moran CRESA

Published in Detroit

Businesses are successful in part by remaining keenly focused on a core product or service offering. This focus includes allocating management time and cash to support and grow the business. Often companies that own their real estate are able to redeploy these resources for additional growth by executing a sale/leaseback strategy.

“Many companies that own real estate are able to generate substantial proceeds through a sale/leaseback,” says Ben Smith, vice president of Plante Moran CRESA.

In addition to monetizing an owned real estate asset to provide cash flow to reinvest in your core business, sale/leasebacks can allow you to devote more time to your business.

“Being a tenant in your building instead of an owner may shift the responsibility of property management to another party,” he says.

Smart Business spoke with Smith and Josh Lanesky, senior associate at Plante Moran CRESA, about who can benefit from sale/leasebacks and how to approach them.

What is a sale leaseback?

A sale leaseback occurs when a business sells a building that it owns and occupies to an outside investor and subsequently enters into a long-term lease agreement with that investor as part of the transaction.

Once any pre-existing debt on the building is retired, the company is able to utilize the sale proceeds to reinvest in its core business or to meet other financial obligations. While this results in an ongoing lease obligation, the return on investment on redeployed capital can often outweigh this cost.

What are the drawbacks?

Because of the dramatic reduction in real estate values that has occurred since 2008, the existing debt on a building may exceed its market value, even with a lease in place. If this is the case, it is not advisable to perform a sale/leaseback transaction until that debt obligation is reduced. There are also instances, particularly in family-owned businesses, whereby the corporate real estate portfolio is held in a separate entity also controlled by the family. Often, this is considered a separate profit center and is used as an estate planning tool.

What kinds of companies qualify to execute a sale/leaseback?

Companies or other organizations with a strong balance sheet and owned real estate are excellent candidates to enter into a sale/leaseback transaction. It is important to note, however, that to successfully execute this strategy, the company must be willing to enter into a long-term lease with the investor purchasing the building.

At a minimum, the financial and risk metrics of the transaction will not be palatable to an investor unless a lease term of at least 10 years is in place. Effectively, these investors are purchasing a stream of future rental payments, so the investment is analyzed based on the overall risk and stability of that future cash flow.  Accordingly, investors seek companies with a healthy balance sheet and a proven operating history.  This allows for easier leveraged financing for the investment, and supports investor interest in the transaction.

Finally, sale/leaseback transactions often occur as part of a merger or acquisition transaction. If the purchasing company does not desire to acquire the real estate with the business, it will many times conduct a sale/leaseback transaction concurrently with its acquisition of the business.

Why is now a good time to consider this?

The current state of the capital markets is extremely favorable for investors — interest rates are at historic lows, and this low cost of capital allows investors to earn greater returns on leveraged investments such as real estate.

Additionally, many market analysts expect inflation to occur over the next several years.  Deploying capital at low interest rates in stable real estate investments allows investors to ‘hedge’ against inflation and protect returns.

Where can a business turn for assistance with a sale leaseback?

Any organization considering a sale leaseback should consult with an independent, professional real estate adviser to ensure that its interests are represented. Your adviser should have the ability to assess the transaction holistically, understanding the perspective of the investor and providing advice as your fiduciary to ensure that the value of the transaction is maximized and the terms are fair. Utilizing this perspective, your adviser can present the investment to a broad marketplace of potential investors to fully leverage a competitive environment and help you identify and select the best offer.

How can a business initiate the process?

The first step is to consult a professional real estate adviser who can help identify the parameters of the transaction and the potential value that could be generated by the sale/leaseback. Together, you can determine the value and impact of the transaction to your business and define the best path forward and implementation strategy. Your adviser will help you gather and review the due diligence items required for the transaction, including financial statements, environmental reports, surveys, historic operating expenses, maintenance records and title work. These items are crucial for investors to review when determining the risk and return associated with doing the deal.

How long does a transaction take to close?

The timing can vary, but typically there is a defined marketing period for the investment, followed by a ‘call to offers.’ This can last from 30 to 60 days. Once offers are reviewed and one is chosen, the investor will require additional time to review due diligence items and arrange financing. This period could be up to 90 days.  Once that is complete, if the investor opts to move forward with closing, the transaction should be complete within 30 days.

Ben Smith is vice president of Plante Moran CRESA. Reach him at (248) 223-3275, benjamin.smith@plantemoran.com or visit www.pmcresa.com. Josh Lanesky is a senior associate with Plante Moran CRESA. Reach him at (248) 603-5092 or joshua.lanesy@plantemoran.com.

Insights Real Estate is brought to you by Plante Moran CRESA

Published in Detroit

Are you getting the most that you can out of your property? If you’re not using cost segregation — a little-known method to accelerate tax deduction applied to capitalized costs for many property owners and lessees — you may be missing out.

Scott Smith, an associate in the Tax Solutions Group of Plante Moran an affiliate of Plante Moran CRESA, says that this technique is often overlooked during the construction and acquisition of property, but in both of those transactions, it could provide immediate cash benefits.

“Using cost segregation as part of your planning can potentially free up money to do more on your project or to get back on budget,” Smith says.

In many cases, 10 to 30 percent of a building’s cost can be reclassified into shorter-lived asset classes, such as personal property and land improvements. These asset classes have significantly shorter depreciable lives than that of the building itself, allowing for faster write-offs than would normally be available by classifying the building as one item.

Smart Business spoke with Smith about how to apply cost segregation and the benefits you can realize by doing so.

What is cost segregation?

Cost segregation is the process of taking capitalized costs that generally depreciate over decades and doing a detailed engineering study that fully utilizes IRS laws and rules that allow you to accelerate depreciation. A cost segregation professional who is familiar with construction and the tax laws will apply the facts and circumstances to any given facility to maximize the benefit to the property owner.

What are the benefits to undertaking such a study?

Many property owners will put an entire property on their fixed asset schedule as a single line item and, as such, it will depreciate uniformly over time. Cost segregation takes the depreciation that would normally accrue over 39 or 27.5 years and makes it available to be depreciated between five and 15 years. This creates a net present value that frees up money for the taxpayer to do things such as expand the business, fund future projects and buy new furniture.

For example, reclassifying $100,000 in assets from 39-year property to five-year property will result in approximately $19,000 in net present value savings, assuming a 6 percent discount rate and a 40 percent composite tax rate.

What assets can cost segregation apply to?

In an office setting, it can apply to items such as carpeting, wallpaper, decorative lighting and cabinetry. In manufacturing, assets such as process electrical, process piping and HVAC, and equipment foundations should be considered. The depreciable life on these assets is generally five or seven years.

On the outside of a building, look at land improvements such as parking lots, site lighting, landscaping, retaining walls, sidewalks, curbs and gutters. The depreciable life on these assets is generally 15 years.

What types of companies should consider cost segregation?

It is beneficial for companies that have built, renovated or acquired a facility and need to offset some of their income — really, any company that has to capitalize costs that it has paid for. In general, the value of the construction or acquisition should be in excess of $1 million to feel the benefit from a cost segregation study. Companies can even go back in time. Say, for example, you purchased a building in 2006 and put it on your fixed asset schedule. Provided that the documentation and records are good, you can do a cost segregation study in the current year and ‘catch up’ any missed depreciation, all the way back to 2006, in the same year. This missed depreciation is called a 481(a) adjustment and can be claimed by filing the proper paperwork without having to amend any prior tax returns.

When is it a good time to do cost segregation?

The best time to do it is right after you buy, renovate or construct property, for several reasons. The documentation at that time is readily available and not collecting dust in a box somewhere. Also, the people associated with the construction are still available and information is fresh, which ultimately increases the quality of the study because fewer assumptions need to be made.

Who should conduct the study?

Choose someone who’s reputable and qualified. The IRS has issued an Audit Technique Guide that serves as an outline of what a quality cost segregation study includes and who is most capable of doing it.

If you use the wrong person — someone who is not familiar with tax law or construction — that person might not provide the detail that you need to pass an IRS audit if one should occur, which could result in interest and penalties. Make sure that you’re working with someone who understands both engineering and tax law to ensure that you get good results.

Why should companies take advantage of this opportunity now?

For certain years, the IRS has said that not only can you accelerate depreciation through cost segregation, you can also qualify for substantial bonus depreciation in the first year on new property. This year, the rate is 50 percent, which means that you’ll accelerate the depreciation on half of a qualifying item’s value, in addition to the percentage you would normally get in the first year. Imagine depreciating more than half of your new carpeting or parking lot in the first year. If you constructed property in 2011, the rate is an unprecedented 100 percent.

Businesses should take advantage of this opportunity now, as it is currently set to expire at the end of this year.

Scott Smith, LEED AP, is an associate in the Tax Solutions Group for Plante Moran, an affiliate of Plante Moran CRESA. Reach him at (248) 603-5203 or scott.smith@plantemoran.com.

Insights Real Estate is brought to you by Plante Moran CRESA

Published in Detroit

With the real estate industry showing signs of improvement, now is the time to take advantage of the soft market and recast your lease.

“This very well may be the bottom for the commercial real estate market as it relates to lease rates,” says Rick Pifer, vice president of Plante Moran CRESA, a real estate consulting firm in Southfield, Mich. “You are in a leveraged position to use your tenancy to lower lease rates.”

Nearly $50 billion in loans on commercial buildings are coming due within a year, written during the height of the real estate bubble, and your continued long-term tenancy offers strong leverage for the building owner during the refinancing of these loans. Vacancy rates, which climbed rapidly in 2007, have remained level for three years and appear to show signs of decline. The window of opportunity to lock in the most aggressive rates and take advantage of a tenant’s market may be closing in the very near future.

Smart Business spoke with Pifer about how companies can take advantage of the current real estate climate to lock into a better lease, before it is too late.

Why is now the best time to consider a recast?

Commercial building loans are typically in duration for five-, seven-, or 10-year terms. As loans are coming due, building owners are in a position where they are forced to refinance, so the length of term remaining on your lease is more valuable than the lease rate itself.

A landlord ideally wants 95 to 100 percent occupancy at all times. Vacancies cost a lot of money in operating expenses and lost rent, and securing new tenants adds to that bill.

The high rate of vacancies we have seen in the down market has really hurt property owners, and they need to retain tenants. This makes them more willing to negotiate on your lease obligation in exchange for a longer commitment from you.

But rates actually appear to be going up as vacancy decreases. There has been relatively no new construction of speculative office buildings over the last four to five years, and for the first time in that time period, the trend appears to be toward decreased vacancy rates.

As a result, we are seeing positive absorption, which means more space was leased in the market than has become available. Lessees need to take advantage of the market before it rebounds.

How many years should a lessee have left on a lease to consider a recast?

As long as you are more than halfway through the term or have less than four years remaining on the lease, you should consider a recast. It may not always make sense to do it, but it is something that should at least be evaluated as a potential cash flow relief.

What other determining factors should a lessee look at when considering a recast?

One of the main components is the building and location. Do they make sense from a long-term, strategic position? If the answer is yes, then locking in today’s market makes a lot of sense strategically and financially.

You are looking at making a commitment of time to a building. If the building works for your organization and you do not have any reservations about making a long-term commitment to the building, then recasting the lease makes sense.

Should a lessee approach the landlord directly to renegotiate?

No. One of the key components in renegotiating is utilizing a tenant-only representative, someone who has no independence issues as it relates to representing the landlord. The representative advocates solely on behalf of the tenant’s interests and has a fiduciary responsibility only to the tenant.

Tenants sometimes feel that they are in a position to approach the landlord directly, but what they overlook is the fact that the landlord is a real estate professional. Handling real estate transactions is what they do day in and day out, which has helped them be successful as a landlord. A lot of leverage can be obtained with market knowledge, which may not be readily accessible to those who are not working in the real estate profession on a daily basis.

Also, if a tenant approaches a landlord directly, the seriousness of the intent is a hard message to deliver. It is similar to telling someone you are going to sue them. It is more effective if an attorney sends a letter than you saying you are going to do it. If someone hires the services of a tenant-only representative, the landlord understands the seriousness of the intent of the tenant.

Additionally, there is always the opportunity to re-evaluate space utilization in making sure that the space is working and is optimized for the business. Look for a tenant-only representative who can take a strategic approach in looking at all facets of the real estate instead of just looking at the lease rate. It is important to evaluate all of the components of the lease and align the space to the strategic business plan from a real estate perspective.

That will allow you to get a strategic real estate decision that allows you to optimize your tenancy to leverage the best deal the market will offer. In addition to a lower lease rate, you may be able to negotiate for a rent abatement provision, more flexible cancellation provisions, lowered operating expenses and updates to the space’s interior.

Rick Pifer is vice president of Plante Moran CRESA, a real estate consulting firm based in Southfield, Mich. Reach him at (248) 223-3698 or www.pmcresa.com or rick.pifer@plantemoran.com.

Insights Real Estate is brought to you by Plante Moran CRESA

Published in Detroit

The office is evolving. New generations of tech-savvy, collaborative employees are knocking down cubicle walls and the corner office while shrinking real estate footprints.

By actively creating a more open environment that inspires ideas and increases productivity, employers are seeing benefits in increased morale, talent retention and lower real estate costs. This is occurring not only at the latest social media/Web startup but also at long-established corporations in a wide variety of industries across the country.

“Multiple studies, and even our own experiences, have shown that this new approach to office space is working,” says Gino J. Del Pup, senior associate of project management for Plante Moran CRESA, a real estate consulting firm based in Southfield, Mich. “This allows for a more efficient work model and a more innovative workplace, while also reducing your usable square footage significantly.”

But in order to foster such success with a new office design, there must be a clear vision and a keen understanding of who you are and where you want to go as a company.

“It’s not just a cool design, it’s a cultural change that a company has to make,” Del Pup says. “If it’s not done correctly, you’re not going to encourage innovation; you may just do the opposite.”

Smart Business spoke with Del Pup about how employers can make office design changes that get results.

How can supporting different work styles help your plan succeed?

People tend to work in a variety of ways, but four distinct styles are common: focus work (‘heads down’ work); collaboration (working with more than one person); learning work (learning by listening to others); and socializing (working in an informal setting with others). By understanding how people work, you can begin to design a space that embraces these styles to ensure a successful outcome.

Do you need to embrace employees across generations?

Definitely. We’re seeing a generational shift in who’s coming into the work force. The traditional office model that everybody is used to — private offices and rows of workstations — is inefficient and doesn’t speak to Generation Y and the Millennials. These groups generally respond better to flexible work environments that allow them to work out of the office, multitask, socialize and work in teams. At the same time, you cannot ignore the more seasoned individuals who are used to, and perhaps prefer, the more traditional work setting.

In many organizations, professionals in their late 40s and early 50s will likely continue to work differently than 20-somethings. To account for this, private offices are still important, but they are becoming smaller and not taking up the corner window anymore. The most successful companies respect and accommodate a variety of working styles, rather than forcing one style onto the entire office.

Why is it important to provide a home base for employees?

Even though people are working more and more away from the office, everybody still likes that sense of being, or that sense of home. We are social by nature, so we need that interaction with others. The office provides that home base to socialize, connect and collaborate with coworkers.

Current design trends confirm this, as companies are designing lounges, workout facilities and game rooms into their floor plans to improve morale, but more important, to give people a reason to come back to the office. The byproduct of this design rationale is employee retention.

How can technology help foster innovation?

Technology is a key component in creating a successful, innovative, collaborative environment. Previously, we simply did not have the technology that encourages a non-traditional work environment. We were tied to our desks. Wireless access was nonexistent; there was no VPN and no mobility. And cubicles hardly promoted innovation. In 2012, employees can work from any location. Advances in technology have created a new work environment; you can be at a workstation, in a meeting room, or 1,000 miles from the office and still have technology work for you.

What specific examples you are seeing?

It’s extreme, but an office where nobody has an assigned seat — much like a hotel, you reserve your ‘space’ online the night before, or as you walk into work. Employees utilize lockers to store their personal belongings each day and secure file cabinets for their work product. Private offices are located away from windows and are often shared. Meeting rooms are in abundance, as are private ‘call booths.’ I’m also seeing an increase in ‘benching’ in offices, where individuals work along each side of a long table. It seems counterproductive, but it forces people to interact and problem solve firsthand — it’s quite unique and something we will see a lot more of in the future.

How can changing your model save on costs?

Real estate has become very expensive, and a byproduct of this design philosophy is that you can ultimately reduce the square footage of your real estate. We’re finding that upward of a third of your real estate can be reduced by going to this model.

How can a company’s brand be important in workplace innovation?

It’s a key component to a company’s culture; it’s who you are to the outside world. Whether it’s the style of workstation, the color of the walls, environmental graphics, or architectural elements, these features can help reinforce your message to employees. People want to work for a brand they admire. When your brand can speak to innovation, collaboration, employee retention and intelligent use of space, you’ll have the edge.

Gino J. Del Pup is senior associate of project management for Plante Moran CRESA. Reach him at gino.delpup@plantemoran.com or (248) 603-5097.

Published in Detroit

Industrial site selection involves so much more than just the cost of real estate. Brandon Podolski, partner and industrial sector leader at Plante Moran CRESA, stresses the importance of taking many factors into account before considering a real estate transaction, regardless of whether it involves entering a new state or moving to a neighboring city.

“Too often, when companies are expanding or consolidating locally, they spend 90 percent of the time looking at the lease rate or real estate costs and don’t account for the impact on operations, labor, cost of goods sold, expenses, taxes and supply chain, or investigate all available incentives,” says Podolski. “These are just some of the components we analyze in a national site search, and they also make an impact on a local scale. Whether leasing, buying, or building, this is more than a real estate deal; it is a business decision that requires due diligence and thoughtful analysis. An experienced adviser can identify and evaluate all of your options and develop a real estate strategy that is closely aligned with your business plans and goals.”

Smart Business spoke with Podolski about creating a competitive advantage through an informed and professional approach to site selection.

How should a business approach site selection?

Companies with multistate operations will commonly analyze the cost benefits of prospective locations in terms of labor, logistics, taxes, incentives, utilities, real estate and other location specific factors. Each of these variables can impact the true cost of conducting business at a selected location. Being proactive can make a sizeable difference.

Can you expand on the critical factors of national site selection?

Logistics plays a key role in selecting the best location. When you think logistics, the first thing that comes to mind is transportation; however, that is just one component. Logistics is the planning and execution of efficient and effective flow and storage of all goods, services and related information to meet customer requirements. Analyzing your existing customer and supplier base and how it ties into a location decision and impacts operations, cost and timing can be a prominent factor in where to locate. Businesses should also examine where they procure raw materials in determining the best location for expansion or new investment.

Transportation costs remain an important consideration in location strategy.  It’s important to understand freight requirements before deciding on a specific site to ensure necessary access to interstates, rail and airports, as appropriate, as a location many miles from the main interstate is not conducive to an operation heavily reliant on truck shipping. Modeling how these costs will change based on proximity to suppliers, warehouses and customers is an important consideration.

How can taxes and incentives influence decisions?

State tax structures and incentives are one of the primary items in national site selection. Rates for franchise, and real and personal property taxes can differ significantly from location to location. Corporate income tax structures vary greatly, as well, and some cities have an additional payroll or inventory tax. Some states are more willing than others to offer tax abatement programs, sometimes specific to an industry such as advanced or high-tech manufacturing.

It’s important to conduct detailed due diligence to determine what the tax impact will be on your business and leverage any applicable state and local incentive programs. Many states have an economic development staff that can offer creative programs to help make locating in their state more affordable. Having a trusted adviser in your corner, one who is committed to your success, can be very valuable in this regard.

What part do labor costs play?

Labor costs and availability are significant factors in site selection, and they vary widely across the country. A great incentive package does not necessarily mean the best business decision if it leads you to an area where the pool of employees does not match the skill sets your organization needs or its projected growth. Industrial organizations need to look at their requirements for engineers, highly skilled employees and general labor compared with salary rates and availability for each prospective location. Also, if you are a large user of energy or water, compare the cost of utilities across markets. Water rates are significantly higher in certain states and need to be factored in the analysis. Negotiating utility costs is an often-overlooked strategy.

How does this strategy apply to businesses looking to relocate or expand locally?

Understanding the best practices of national site selection allows companies to look at local real estate transactions differently. The more factors about potential sites you arm yourself with, the more information you have to make a smart business decision and gain a competitive advantage. Working with an adviser when you have a new project or are in the quoting stages can give you the time necessary to conduct a thorough analysis of all options.

Comparing variables not specific to the buildings can tell you the true cost of a location beyond the price of real estate. Analyzing local property tax rates and location-specific incentives provides another perspective to a local real estate transaction. Comparing logistics costs and the proximity to customers and suppliers are also key components. While utility rates may not significantly differ in a local transaction, the energy usage and efficiency of facilities can be estimated based on roofing, windows, lighting and HVAC equipment.

The bottom line is that choosing a location based solely on where real estate costs are the lowest can cause other factors to become unaligned. That’s when market knowledge and a disciplined approach to the selection process become critical, even when assessing locations within a small radius.

Brandon M. Podolski, JD, is a partner and industrial sector leader at Plante Moran CRESA. Reach him at (248) 223-3245 or Brandon.Podolski@PlanteMoran.com.

Published in Detroit
Page 1 of 2