The implementation of the Sarbanes-Oxley Act of 2002 has had a significant impact on financial reporting for public companies. Enacted by Congress in response to high profile business failures (think Enron and WorldCom), SOX holds public company executives personally responsible for financial statements and they may be criminally liable for misrepresentations or omissions.
The cost of compliance for public companies, in terms of dollars and time, can be staggering.
Privately held companies and charitable organizations are generally exempt from complying with SOX provisions. But SOX has an impact, either directly or indirectly, on every organization, including their real estate activities.
“Being SOX ready can be a competitive advantage, as public companies may look more favorably on doing business with you,” says Peter J. Licastro, senior manager of brokerage and leasing for Grant Street Associates Inc.
Smart Business spoke with Licastro about how SOX affects commercial real estate, why nonpublic companies should be concerned about SOX and best practices to adopt that can help you save money and improve your business.
How does SOX affect commercial real estate?
Real estate is often one of your most significant assets and/or expenses. Because of its significance and the fact that many business operations are becoming decentralized, either nationally or globally, real estate can present a variety of risk factors, including:
n Substantial differences in the book value versus market value of owned properties
n The existence of structured lease or ‘off-balance sheet’ transactions, such as synthetic leases
n Commitments and risks embedded in, or associated with, leases. This could include substantial rent bumps, critical notification dates for lease renewal or termination rights, leased space that is not occupied and may be subject to accelerated loss recognition of tenant improvements, as well as the liability for the remaining lease payments.
n Property with known or latent environmental issues
Why should nonpublic companies be concerned about SOX?
SOX is rooted in disclosure, transparency, risk identification and internal controls. The ripple effect of SOX can range from standards for the physical security of data centers to the accounting treatment of surplus property or sublease space.
For public companies, compliance with Section 404 Management Assessment of Internal Controls is an organizational mandate as they must certify that adequate internal controls govern their operations. If the activities of a service provider are critical to the information system of the company in the creation of financial statements or disclosures, then validation of the service provider’s internal controls may be necessary. Depending on the circumstances, this may be accomplished by obtaining a Service Auditors’ Report from the service provider, performed under an auditing standard known as SAS 70.
Public companies are asking their nonpublic providers of outsourced services, such as facility management and accounting, lease administration and project management, to implement controls similar to those required of the public company. This can raise a number of issues though, such as whether or not your vendor is contractually required to provide SAS 70 type assurance.
What best practices can private businesses or nonprofit organizations adopt for leased or owned real estate?
Private organizations are in a unique and enviable position with regard to SOX, because they can cherry-pick provisions that have the greatest benefit at minimum cost. While outsourcing services and automating processes can help improve effectiveness and reduce costs, best practices can also include basic initiatives, such as promoting a company-wide focus on better documentation of real estate activities and decisions.
If you are decentralized, consider centralizing higher risk decisions, such as purchasing or leasing property and construction or renovation projects in a more standardized environment.
Develop and maintain a complete listing of all properties, owned or leased, service contracts and vendors. Utilize checklists for property acquisitions and dispositions, bidding out and managing construction or renovation projects.
Create a lease administration system by carefully abstracting leases for critical dates, terms and financial commitments. Depending on the volume, a database can be used to generate reports of lease expirations, and dashboard metrics such as rent expense as a percentage of business unit revenue.
How can you start implementing these best practices?
Getting started is easy. First, make sure you have fully executed leases on file, including all exhibits and amendments, not just the faxed signature page. Are there leases with onerous automatic renewal provisions lurking or with critical notification deadlines in order to preserve lease renewal or termination rights? Surprises are a bad thing when it comes to SOX and real estate.
Peter J. Licastro is senior manager of brokerage and leasing at Grant Street Associates Inc. Licastro advises tenants and landlords, owner/users and investors. Reach him at (412) 391-2635 or firstname.lastname@example.org. Grant Street Associates Inc. is a full-service commercial real estate firm and a member of the Cushman & Wakefield Alliance.