How Companies Account
For Vacant Office Space
Across the nation, companies have shut off the lights in office after office as layoffs or cutbacks have rendered the space unnecessary. But just how the companies are accounting -- or not accounting -- for their deserted office space is raising nettlesome questions.
What's at work is a change in rules that took effect Dec. 31 governing how companies write off empty real estate. The new rules hit as empty space nationwide is skyrocketing, and some companies have, at best, just handfuls of workers dutifully toiling away on nearly vacant floors.
Under the new rules, set by the Financial Accounting Standards Board, a company must write off the cost of unused real estate either when it terminates the lease or when it "ceases using" the space. The new rules represent an effort to toughen the previous ones, under which companies were required to account for unused space only when they developed a so-called facility exit plan, which generally means a plan for pulling out of the space.
The old rules gave companies notable leeway to decide when to account for potentially large charges against earnings because they could set their own timetable for writing up the exit plan. "The idea that a liability was created by simply adopting a plan was always weak," says Eugene E. Comiskey, professor of accounting at the DuPree College of Management at Georgia Institute of Technology in Atlanta. "It provided a great deal of timing flexibility."
But many accounting specialists say the new standards still provide latitude for companies to interpret the rules in their favor, perhaps by suggesting they could reoccupy the space at a future date or because they are still using part of it.
To understand the latitude that may be in the new rule, consider Goldman Sachs Group Inc. Real-estate executives say it has one of the largest caches of empty office space in Manhattan at the moment. In anticipation of future growth, the securities firm in 2000 signed a 20-year lease for a 550,000-square-foot building at 77 Water St., near Wall Street, but then never moved in. It currently is subleasing a few floors to other companies. In addition, after the terrorist strikes of Sept. 11, 2001, the company vacated 350,000 square feet -- or nearly nine floors -- at One Liberty Plaza, a building overlooking Ground Zero.
Neither of those buildings is currently on the market, and a Goldman spokesman, Lucas Von Praag, says: "We don't have to write it off if we don't want to," saying the rules allow for management judgment.
If Goldman was to write off the space under the new rules, the 77 Water St. building alone would likely generate a charge of $75 million, or nine cents a share, estimates Justin Hughes, an analyst at Jefferies & Co. in San Francisco, who doesn't take a position on whether a write-off is warranted. (Goldman reported per-share earnings of $4.02 in the fiscal year ending November 2002.) Mr. Hughes's calculation is based on lease terms provided by real-estate sources; the calculation reflects the net present value of the remaining lease payments, less the likely sublease income the company could get in this market.
For its part, a FASB representative says the new rules "provide better guidance of when an obligation really exists and when a company should take a charge to account for it in connection with an exit activity." And following a year of high-profile accounting blowups, the new standards could make it harder for some companies to justify what previously might have been a close call, with growing numbers of investors wary of companies that meet the letter but not the spirit of accounting standards.
The haziest cases will be those where a company currently isn't using the space but hasn't yet offered it for sublease, a step that would generally indicate a tenant no longer needs the offices. In New York, real-estate brokers say there are a number of big financial-services companies that haven't put excess space on the market.
As the new rules took effect, national office vacancies were up to 16%, or 530 million square feet, roughly double the rate in the fourth quarter of 2000, according to Reis Inc., a New York real-estate research firm. Those figures understate the problem, given that many companies have so-called shadow space that isn't yet on the market and therefore not reflected in the statistics.
In Manhattan, Robert Sammons, research director at brokerage firm Colliers ABR, estimates that about five million square feet of space is either currently vacant or will be vacated in the next year by tenants who will still have lease payments outstanding. In Silicon Valley, broker Phil Mahoney, of real-estate services firm Cornish & Carey, says that there is as much as 20 million square feet of shadow space on top of 60 million square feet of space on the market.
Some real-estate brokers believe some tenants haven't offered up this space for sublease in part to help avoid a charge. "People are looking at every which way to avoid the write-offs if possible," says Scott Pudalov, a senior managing director at Insignia/ESG, a commercial real-estate brokerage firm in New York. To be sure, many companies encourage investors to ignore such charges, often dubbing them a "one-time event" in their news releases, but generally companies don't like taking these earnings hits.
Even space that is on the sublease market may not be subject to the new rules, according to some tenants. Software company Network Associates Inc. says it doesn't need to take a charge in connection with 200,000 square feet of space it is marketing in its Santa Clara, Calif., headquarters building. Brian Colbeck, vice president and corporate controller, says the company still has some workers on every floor. "Companies still have the ability, based on business plans and forecasting, to make the determination as to whether or not they want to take a charge," he says.
Janice Stanton, a managing director at real-estate-services firm Cushman & Wakefield in New York, notes that some tenants will be able to argue that they have only temporarily suspended use of empty offices on long-term leases. "The question is, if it's surplus for one year or 18 months, that doesn't mean it's surplus over the entire life of the lease," she says.
Many companies already have accounted for the thousands of square feet of empty space that the economic downturn left on their books, in some cases recording hefty charges. Sun Microsystems Inc., for example, wrote off $443 million in the fiscal year ended June 2002 to account for millions of square feet of leased space it no longer uses. Merrill Lynch & Co. took $299 million in pretax facilities-related charges in the fourth quarter of 2001. Dow Jones & Co., publisher of The Wall Street Journal, took a $19.3 million charge to net income that same quarter to account for unused space at the World Financial Center, across the street from Ground Zero.
Some real-estate advisers say that companies that focus on the accounting may be missing the point. David Arena, chief strategy officer in the New York office of real-estate services firm Jones Lang LaSalle, says: "Nobody is paying attention to the problem of acquiring and managing [unneeded] commercial real estate" to start with.
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