Analyst Perspectives

Financial analysts typically classify real estate as a fixed cost. Strictly speaking, that’s correct, but looking at it this way leads many organizations to overlook opportunities to more carefully manage their real estate and other occupancy expenses. The changes in lease accounting that are going into effect have caused some organizations to reexamine their leasing policies and how they organize their lease accounting processes. They should take an even broader approach and consider ways to improve how they manage those leases.

In industries where occupancy or ownership costs account for more than 20 percent of total business expense, taking a more active approach to managing real estate and occupancy can improve a company’s profitability. But in most cases achieving a higher return from money spent on corporate facilities requires some organizational and process changes.

For many companies the fact that real estate is a fixed cost means that they rarely spend time considering their options for reducing this expense or making better choices for locations and facilities. Industries in which occupancy costs are one of the top three expense categories, such as retail or consumer-oriented financial services, pay more attention; these businesses often have departments responsible for managing leasehold costs, site selection and other aspects of occupancy. But other businesses also could control this expense much more effectively. There’s an organizational component to this: centralizing occupancy management as a shared service. There’s also a technology component: ensuring that all relevant data is readily accessible through a dedicated application – not spreadsheets – to manage the administration of these sites.

Larger companies that are not big retailers may have a substantial number of offices and other leased locations that, when taken together, constitute a sizable opportunity to manage their utilization and cost more advantageously. Yet most distribute the responsibility for handling these sites across divisions, business units or even more narrowly.

Managing real estate across the entire company as a shared service may be a more efficient approach. A central real estate management function can support all of the business units’ real estate decisions, monitoring and managing enforcement of lease terms and conditions as well as enabling a more long-term, strategic approach to facilities. But it’s important that if a company centralizes its real estate function it has the full range of capabilities to support the business units that will be utilizing the space.

Software can provide some of those capabilities. One of the powerful transformative contributions made by information technology has been to change the given constraints of running a business. For example, companies do a far better job of managing physical goods than they did a generation ago; computers made lean inventory management feasible for average organizations. Over the past two decades, business processes have evolved as new categories of applications have become available and as the scope of information available for analysis and decision support has broadened. Managing real estate facilities and expenses is one of these areas where, with the right software, companies could save money and work more effectively with suppliers and customers.

Software designed specifically for managing real estate has many of the routine functions users need and often enables better practices than most companies are using. For example, many companies could make better-informed decisions when it comes to arranging or renewing leases. Typically, the individuals who are responsible for a particular site or business unit rely on brokers to keep them in touch with real estate availability and market conditions. While brokers can be invaluable for many services, they may not know (or offer) every appropriate and available option. Software that taps into commercial real estate databases can provide insight and analysis that enables companies to negotiate better terms than they might otherwise.

Moreover, once a lease is negotiated, companies routinely do not follow up on all of the provisions that can save them money, such as those limiting assessments, or fund improvements for structural enhancements beyond an initial build-out; real estate applications can keep track of these contingencies. A software-supported shared-service approach also can do a more effective job of handling day-to-day administrative tasks such as managing maintenance and construction costs or optimizing space utilization across the organization.

Spreading the cost of dedicated software across the entire organization makes this approach more affordable. Shifting away from a manual approach and desktop spreadsheets makes the process more effective. It ensures that organizations handle their processes consistently, anticipate deadlines and perform the necessary follow-throughs.

Occupancy expense is an item that many companies watch but do not have the methodology and capabilities to manage well. In some cases, it may make little difference, especially if a company’s occupancy costs are a small percentage of operating expenses or if it operates in a small number of locations. But many larger corporations, even those that are not in businesses that require them to manage a large number of retail sites covered by complex leases, can benefit from taking a more strategic approach to managing their occupancy costs. They can reduce their ongoing expense and have sites that better suit their needs.

At the same time, companies should recognize that most software for managing their real estate leases doesn’t have adequate functionality for lease accounting. This means they must either buy lease management software that has established links to their ERP system or create a system for passing data from the lease management system to their ERP or financial management software.

Spreadsheets, the mainstay of accounting departments, are no longer a practical option for handling the processes of collecting lease data and performing lease accounting in situations other than where an organization has only a handful of leases. Most midsize and larger corporations have more than that. Indeed, large companies typically have hundreds and even thousands of property and equipment leases in force at any time. Capturing all these data points accurately in desktop spreadsheets is problematic because of control and accuracy issues.

Spreadsheets have numerous inherent defects that make them unsuitable for repetitive collaborative enterprise tasks such as lease accounting. For example, our Spreadsheets in Today’s Enterprise benchmark research finds that more than one-third (35%) of participants have data errors in the most important spreadsheet they use in their work and 26 percent have errors in formulas. More than half (55%) of participants that use spreadsheets all the time said there are multiple, inconsistent versions of the same spreadsheet circulating frequently or all the time.

Software designed specifically for lease accounting is the better choice. I advise companies to reexamine their lease management and accounting processes to determine how best to use information technology that can improve financial performance, speed processes and ensure accuracy.

Regards,

Robert Kugel

SVP & Research Director