In the aftermath of the pandemic, many organizations are re-evaluating the amount of available workspace in their leases, whether for space management or financial reasons. This requires real estate accountants to modify leases properly and stay compliant with GAAP and lease accounting processes.

What is a modification of a lease under GAAP?

Any changes to your financial obligation during the term of the lease will cause a modification to your lease accounting capitalization schedule from the date you realize the change until the end of the term. Modifying a capitalization schedule may require a different set of calculations than your original lease schedule. When you modify your lease schedule due to a change in the term of the lease, or a change to the liability, you can change the discount rate to be based on the new/remaining term.

Common examples of lease modification triggers include:

• Early renewals
• Extension of lease
• Cancel early
• Contraction
• Each time you receive an allowance payment from the landlord
• Blend & extend
• Rent tied to outside index (CPI) – Different rules for FASB & IASB
• Renegotiate your rent
• Expansion – Creates a new ROU Asset, therefore you will create a new capitalization schedule for the new space as opposed to re-measuring the existing schedule.

Lease accountants need to be aware of what will trigger a lease modification and how to properly account for it. Be sure to work with your legal team and management to ensure all lease changes are accurately and completely included in your financial information.

Accounting questions to ask yourself before entering a lease modification

The current trend of re-evaluating available workspace and leases means that lease accountants need to ensure they’re following compliance guidelines and best practices under ASC 842.

Here are four accounting factors to consider before modifying a lease.

1) Dates – What is the effective date of the modification?

The date in which the modification becomes effective is important when you are entering changes under the new standard. Your accounting policy will dictate when the negotiations are considered final, whether it’s in writing or verbally, and this will become your modification date. There is usually a gap between the official modification date and the effective date of the changes in terms. This impacts the recognition of the measurement of lease liability and ROU asset. For example, a lease extension is being negotiated to start in September 2021 but is signed in July 2021. The effective date of the modification will be July 2021 and all financial information should be adjusted as of that date.

Be careful around quarter or year end reporting and make sure all changes in those periods are included by gathering all pending lease modifications from legal or lease administration. It’s important to use the correct date of modification because it determines what interest rates you use, what expenses are recalculated for the remainder of the lease, and the new liability and corresponding ROU asset.

2) Costs – How will a change in lease expense affect my financial balances? How will current interest rates affect my lease accounting when I modify?

Any increase or decrease in your overall cash payments for the existing lease are going to directly impact the liability and asset on your books. Additionally, the modification date will dictate the interest rate to use on the new liability as noted above. The new lease liability will be remeasured as of the effective date of modification using the new interest rate and lease payments. Any difference in the liability from what’s been previously recorded will be adjusted against the ROU asset.

3) Increasing or reducing existing space – How will my accounting numbers change as I downsize or increase my available workspace?

Often, an existing lease will be modified for the addition of space, which changes the terms of the original lease and a brand-new lease is papered for the same property. For accounting purposes, we can treat this as a new lease with a corresponding interest rate as of the “new lease” date for all the new space. The new lease will begin immediately following the end of the old one.

If an existing lease is continuing with no changes and additional space is being leased from the same landlord, then the new space should be accounted for as a new lease with current interest rates, and the existing lease should remain unchanged. These will be treated as separate leases under their respective terms.

Any reductions in lease space would be considered partial terminations and the liability and ROU asset must be reduced as of the effective date of the modification. This may also result in a gain or loss for any difference in reduction of the lease liability as compared to the reduction of the right-of-use asset.

4) Lease term – What if I am extending my lease term? Will I include options on the modification? How are my balances impacted by a reduction in term?

If you are extending a lease, the effective date of the modification will dictate the new interest rate which will be used to calculate the liability and adjust the ROU asset. This should not be accounted for as a new lease, but as a modification. Consider if any options were previously included as reasonably certain upon adoption before adding the new amounts, as they would have already been included in your balances.

A reduction in lease term will result in a modification of the liability and asset that is less than you have recorded. Any early terminations may result in a gain or loss for any difference in the reduction of the lease liability as compared to the reduction of the right-of-use asset.

If you are modifying a lease to end earlier and you had previously included options that were not exercised, you will have a decrease in the liability and potentially an adjustment to expense for the inclusion of the option payments in the original liability. Reasonably certain options that may have been included upon adoption potentially are not deemed certain upon modification of the lease due to new economic circumstances and will need to be considered for the modification.

Using software to simplify the lease modification accounting process

Utilizing purpose-built software can make it easier for you to follow the proper processes when entering lease modifications. MRI offers a variety of lease accounting software solutions for both SMB and enterprise organizations that can help you stay in compliance with IFRS 16, IASB, GASB, and FASB requirements. Keep your organization in good standing with software that simplifies journal entries for rent concessions, capitalization schedules for payments and asset management, and audit trails to easily access and review your data. See how MRI’s lease accounting solutions can benefit your business in the aftermath of COVID-19 and beyond.

In an era where real estate firms are inundated with data, it can be hard to know what data is most important to your business, and it can be even harder to uncover that information in the first place. CFOs and Controllers in real estate firms need to track commercial real estate metrics to ensure the success of the business, but gathering all the necessary data to calculate key metrics is difficult as it can be scattered across the organization. With all the manual work it takes to track down data, the metrics will likely be out of date by the time you get around to using them.

With a business intelligence and analytics solution, commercial real estate firms can visualize their current business metrics, monitor KPIs and drill down to the granular details to make strategic data-driven decisions and deliver for investors.

Here are just a few of the financial metrics that your commercial real estate firm can and should be tracking with an analytics solution:

1. NOI

The right analytics solution can not only give you a visual representation of your net operating income – it can also show you the underlying metrics that influence it, like capital and operating expenditures. With the capability to drill into these stats, you can better understand the ways in which they impact your business and better identify how best to prioritize your organization’s time.

2. Receivables tracking

All businesses have certain expectations when it comes to payments from their tenants, and with the power to keep track of your receivables in an easily accessible dashboard view, you’ll be able to identify late payments and assess risk and impact to cash flow based on that information.

3. Budgets vs. actuals

Your organization’s budgets are designed to meet the strategic goals of the business, and by not tracking to those budgets, you run the risk of missing your marks. With an analytics solution, you’ll be able to gain visibility into deviations and track your budget against your actuals, without the hassle of digging through data. Comprehensive dashboards can provide relevant information tailored to your business and personalized needs while still giving you the flexibility to expand upon them if necessary.

4. Occupancy

A high-level view of your occupancy rates gives you not only a better understanding of your tenants, but a more thorough picture of how your space is being used. A solution that helps you visualize occupancy metrics and tenant mix can equip your business with a new understanding of the relationship between your leases and your physical space, instilling more confidence in your strategic planning.

Visualize CRE metrics with analytics tools

A powerful business intelligence and analytics solution can give you a more detailed view of the CRE metrics within your organization, equipping you with the ability to make data-driven decisions and measure success. Learn how MRI Analytix Portal and Data Store arms your business with the ability to assess trends and identify outliers and prepares you to become a data visionary.

For commercial real estate investors and owners, mitigating risk requires making informed decisions based not only on accurate data, but also on the projected return on investment and rate of return. One such tool asset managers can use to assess the value of a given investment is the internal rate of return (IRR) formula.

Even if your current processes and operations include knowing how to calculate IRR, understanding its purpose and how it’s being used in the real estate industry can help guide you in the use of the formula.

What is internal rate of return and why is it important for real estate?

Before investing in a property, real estate investors need to know if that project will deliver profitable returns. In its simplest form, IRR is the percent that an investor will earn if a certain project performs as expected.

This statistic is important for commercial businesses with multiple properties managed by separate parties because it gives a better picture of what your investments might yield, allowing your business to make the determination as to whether a project is worth the time and effort. Calculating IRR requires an input of real data based on real assumptions, which means the data you’re using to make assumptions should be rock solid to ensure accurate results.

How to calculate the Internal Rate of Return

One way to determine the internal rate of return on a project is to calculate it manually by following a set formula. In this formula, the expected cash flows for your investment are given and the Net Present Value (NPV) equals zero. More information on what that formula looks like in practice can be found here, and once the internal rate of return is determined, your business can put it up against the cost of capital to see the financial value of the project based on your new and existing data.

How IRR is used across real estate

Utilizing the IRR formula can help asset managers in real estate businesses not only assess the value of a property now in comparison to other potential investments, but it can help determine the cost of the project over time and in response to different potential scenarios.

However, most property management systems don’t have the ability to calculate IRR in-system, which leads users to export data from the system into a third-party application, calculate IRR, and then reupload data into their property management systems. Many times, that system can be as unstructured as an excel spreadsheet. The danger in doing this, however, is that the data you plug in to calculate the Internal Rate of Return needs to be as accurate as possible, and whenever you export data into a third-party application that doesn’t integrate with your property management system, errors can come into play quickly.

This problem is exacerbated by the models that many asset managers operate, where employing multiple managing agents means that they have to manually model IRR from multiple disparate data sources. This makes forming a true comparison of IRR across different assets a challenge, often consuming the time and effort of at least one staff member per year.

For asset managers in the real estate industry, knowing how to calculate IRR is becoming an important part of the job. Calculating IRR with a tool that doesn’t integrate with your processes, however, can create increased risk for your business. Learn how MRI Investment Central can integrate with your property management system, keeping all your data on the same track and giving you confidence in your calculations.

This blog was written by Andy Hamilton, a Consultant at Proactis.

Proactis, a certified MRI Software Solutions Partner, helps property management companies control 100% of their spend. Their solution transforms the Source-to-Pay processes, which helps organisations save money and create efficiency gains while increasing compliance and reducing risk.

Over the years, I’ve worked with many organisations in the property management sector, including CBRE, Knight Frank and Savills, to help them drive better value from their spend control and management processes. Through this experience, a number of key themes have emerged:

1. React to changing market conditions with flexibility and agility

Whether you’re managing your own company’s properties or those of your clients, controlling and managing spend is critical in terms of getting the best value possible for the goods and services you purchase – no matter how things change.

If the latest events have taught us anything, it’s to expect the unexpected. And with that mindset brings the need to develop agile strategies that can change should your environment shift overnight. Time doesn’t stand still, financial obligations must be respected, and business needs to keep going.

Some companies have been able to adapt their processes. For example, Proactis customer Honeywell expanded its production at its aerospace facility to manufacture N95 masks for Covid-19 protection.

Other institutions, such as the University of Sussex, have embraced technology to ensure they can keep functioning and, in this case, deliver higher education.

Agile Purchase-to-Pay (P2P) also proved critical for Bright Horizons, with a portfolio of over 320 nurseries, as it enabled the company to respond to the pressures Covid placed on the business when it was forced to shut the majority of nurseries during lockdown. Having the ability to control and manage cost effectively and centralise more purchasing was key to successfully navigating through the initial lockdown.

For Finance teams in many organisations, I have found that the situation has actually highlighted a number of areas that can be improved – not only short-term fixes, but for the long-term running of the business. For example, systems that connect teams, simplify reporting, centralise data and connect with the wider organisation can redistribute workload and reduce paperwork.

The impact of Covid forced many to accelerate their journey on the path to digital transformation.

2. Make it simple, but accurate

Obtaining the best value is critical, not only to success, but in some cases to survival. An agile approach to spend management helps achieve this by improving the effectiveness and transparency of both strategic and tactical sourcing processes, while reducing administrative time and effort. Savings can be realised by driving on contract spend and proactive expenditure control through the P2P front-end.

In complex property organisations in particular, it is key to be able to accurately determine who should authorise spend, how the recoverability should be classed, and ultimately where it should be allocated through the underlying property management system.

3. Gain visibility and control

Visibility of spend, through the entire process – from request, through comparison against service charge, to summary analysis – is invaluable to every level of decision-making. Budgets are tight across most businesses, with many having to do more with less.

It’s crucial for property management firms to closely manage costs against budgets, ensure that costs are controlled within the boundaries of the service charge provision, and have the flexibility to react to operating changes at any stage in a process.

4. Improve efficiency

A common objective, and challenge, that I often hear is whether Finance functions can improve process efficiency or not. For example, a strong P2P process, underpinned by well-integrated technology, supports ‘right first time’ invoice submission. This in turn reduces invoice queries and processing time. Imagine the value and reduced time when an invoice can be matched first time to an approved PO, goods receipted, and suppliers validated!

5. Eliminate overpayment and reduce fraud

Another important goal for Finance teams is eliminate overpayments and reduce invoice fraud. Well-adopted and efficient P2P processes prevent payments to unknown suppliers, duplicate payments, or payments when goods or services are missing. I have found that this often results in significant reductions in wasted resources for the buying organisation.

6. Add value without duplicating functionality

My experiences have proved that you can deploy effective spend control around just about any core system. In fact, deploying spend control that’s aligned with your property management system is the only sensible approach when seeking to deliver truly quantifiable value.

True best-in-class, agile P2P systems are “agnostic” of other systems but are built with clear integration points that utilise industry standards and tools to make integration into a product management system easy to implement and manage. Such integration ensures that you can get best-in-class procurement capabilities aligned with the familiarity of your property management system to deliver simplicity and maximise user adoption.

7. Integration is not just a suggestion

Proactis and MRI Software work in partnership to provide a complete end-to-end system for property companies around the world. Combined, our systems are truly agile and integrate seamlessly with each other. They create a complete solution that enables property management organisations to operate in a more effective way and ultimately better serve their customers.

As we mentioned above, Proactis is an MRI integration Partner! Their procurement and spend management solutions can streamline business processes, ensure compliance and drive down costs. To learn more about Proactis, visit their website.

As the vaccine rollout continues and real estate occupiers across the globe are assessing local health and safety requirements, everyone – from employees to landlords – is asking the same question. When and how will companies bring people back into the office? Answering that question requires finding a solution for the return to work that prioritizes the needs of the business and of its employees. No one office will return the same way, and for that reason, businesses need to have a solid plan in place to address those who wish to work onsite full time and those who are more productive working remotely.

We understand that workplaces are about driving productivity and collaboration, which is why we’re introducing MRI Workplace Central, a set of solutions that enable occupiers to create a safe, flexible work environment that empowers employees to make optimal use of your workplace. Workplace Central can be your one-stop shop for bringing employees back into you’re the office and manage your space requirements as the needs of your business change.

Plan for the right reopening

As one survey showed, most occupiers are planning on bringing their workforce back gradually, with some remaining in their work-from-home schedules full time. Maximize your office space with Workplace Central by easily planning your new occupancy floor plans and return-to-office scenarios to ensure a safe and successful reopening.

When employees come back to the office, they can return to a workplace that is designed specifically for collaboration across teams, whether those teams are in-office or working remotely.

Track who’s on site with presence management

Workplace management isn’t just about office layouts – it’s about establishing clear lines of direction on where employees are supposed to go, having established procedures for visitors, and booking desks for employees working on a hybrid schedule. Gain visibility into who’s on site with solutions that let you fully track the people coming into your building, from visitors to contractors and even full-time employees.

For those who might not spend every day of the week in the office, this means utilizing booking technologies that let them reserve a desk for themselves, schedule a meeting room, and allow visitors into set parts of the premises – all from a mobile application.

Modify the space to suit your needs

The pandemic hasn’t just caused a shift in market trends. It’s completely changed the way we think about office space. The workplace will need to be constantly flexible and open to reinvention based on the needs and desires of its employees. Workplace Central gives you a full view of real time and historical trends to highlight shifts in usage and adjust layouts to meet changing demands for space.

As more employees return to the office and use the space over longer periods of time, you’ll gain a better understanding of how the space is being used. With this knowledge, Workplace Central can enable you to readjust your original plan to better meet evolving space needs, whether that means adding room for collaboration or removing desks.

Optimize your office with usage data

While changes will always need to be made to accommodate your employees, you also need a workspace management tool that gives you greater insight into how changes to your office are impacting the business and how your leases might need to be adjusted as requirements continue to change. Workplace Central lets you leverage reliable, strategic insight into your reconfigured workplace to identify areas of improvement and lease re-evaluation, utilizing AI-powered lease abstraction.

Learn more about how you can utilize Workplace Central to the benefit of your business and your employees in this webinar.