By Ken Ashley
(ATLANTA) October 21st, 2011
As reported in this recent WSJ article, even Warren Buffet
is buying back his own company’s stock. The Journal reports that Berkshire
Hathaway has a stunning amount of cash totaling nearly $50 billion dollars
on hand. In the first 6 months of this year, the company generated $9.7
billion in cash or nearly $54 million per day.
Mr. Buffet is in good
company. According to Deallogic, $347. 5 billion has been squirreled away by corporate America, which is the most since 2008. We read similar stories about Apple, GE, and
many life insurance companies, among others.
In early October, the Journal ran another article “Companies’ $2 Trillion
Conundrum” which again referenced the “massive cash hoards” being built up
now. The article went on to suggest that a “vicious cycle of
underinvestment” may be upon us as corporate America (a) can’t find suitable
investments and (b) continues to worry about the future economic outlook.
Not every company is so fortunate, of course. Many are dealing with cash
flow issues, but this is true in every economy. What is amazing is that
corporations are sitting on such a huge volume of cash combined with
relatively low debt. Even the guru of all financial gurus Mr. Buffet is
spending money on his own stock as opposed to sopping up more companies.
That fact indicates that building huge piles of cash will be trendy for
sometime to come in the executive suite.
Don’t I At Least Get A Toaster With This Loan?
So, why do cash rich corporate tenants reach out to their landlords and ask
for even more money? It’s traditional in many real estate transactions for
building ownership to invest cash in the form of a “tenant improvement
allowance” (“TI”). The landlord then amortizes this cash into the lease rate
over the term of the commitment. Tenants use this money to carpet, paint and
build out their space. The thinking is “This is the landlord’s building and
I’m only here for the term of lease. Why would I dump my cash into someone
Peel back the onion, and you will see that the lender, I mean landlord, is
actually making a tidy sum on that investment in your new space. You knew
this intuitively, but lease proposals are always silent on the
interest rate on TI money. It’s certainly a worthwhile exercise to take a
few minutes to check the math and solve for the imputed interest. Regardless of the decision of your cash or the landlord’s, you can send your broker in to make the interest rate on the landlord’s cash a negotiable item in the deal. I’ll bet in today’s environment you can improve on the first offer.
The length of your commitment will have to factor into this decision on
whose cash to use as well. If you are only committing to a space for three
or perhaps five years, it might be best to let the professional landlord
spend his money on the space. However, in longer term situations, a good
side-by-side analysis will help decide if your cash or theirs is the better
Pass Go and Collect $200
Determining whose cash to put into the build-out is like any other investment decision in the real life Monopoly game we play in business every day. If you invest dollars to pay for some or all of the TI, then you get the depreciation (check to see if bonus or accelerated depreciation will apply to your situation),
and of course you get the benefit of the lower lease rate during the term. You’ll abandon the improvements when you leave the building, but this is true even if the landlord builds out the space and amortizes the cost in your lease rate.
If you let the landlord invest his cash in your deal at your now negotiated
lower interest rate then you get to keep those dollars you otherwise would have spent. But remember, at the end of the term, when you are considering renewing the lease, you should deduct the amount of the TI amortization from the new lease rate. Otherwise, (depending on market rates) the landlord will be happy to leave that line item in your cost at 100% profit.
A big factor in the cash deployment decision has absolutely nothing to do with real estate. Only senior finance executives can see the full picture of a
company’s investment opportunities, including internal projects and M&A
options that may pop up. Admittedly, in most economic cycles, investing in
sheetrock doesn’t even come close to the internal hurdle rate. It’s only
the vast amount of cash lying around at very low interest rates that makes this even a consideration.
At the end of the day, most corporations will let the landlord pay for the
TI. However, you will feel better having run the traps on the analysis and
negotiated this often hidden part of the real estate deal.
Before you finally decide who will write the check on your improvements, asking a few simple questions might significantly improve your deal either way. And
that’s an investment even Warren Buffet can get behind.