Juiced Performance

Sometimes one need only look at the circumstances to determine the results are juiced.  Barry Bonds, Lance Armstrong and this guy.  Hopefully you’ve not been dieting on bull testicles and dried animal organs for the past couple of years striving to live your best “primal” life, only to be disappointed in the results.  I’m no body builder, but at a glance, and absent any knowledge of this man’s history and supposed development of his physique, I’d instantly conclude one thing:  juice. 

It turns out juicing is everywhere, even in commercial real estate.  You see, results are not always what they seem.  There’s a common practice, for example, of “buying up” net operating income (“NOI”) by structuring a transaction to have a higher rental rate by giving more concessions (free rent and tenant improvement allowance).  Why do this?  Well, because it can pay off in the form of increased capitalized asset value on a sale since NOI is a big determinant of asset value (e.g., higher NOI, higher value).  You could have two buildings, comparable in every way, both for sale at the same time but having a significant difference in capitalized “value” because one of the owners structured the leases with higher face rates and more concessions and the other achieved lower rents but funded less in concessions.  From the occupier’s perspective, where most companies are looking at total occupancy cost, which includes rent and capital spending and considering most companies will use GAAP accounting to straight line the rent expense, the impact of a lease with an artificially high rent but more concessions is a relative wash to one in which the rate and concessions are at market.  But this juicing of the results does have longer range negative impacts.  Firstly, it results in a higher valuation at sale, translating to a greater tax increase, which in the context of San Francisco office leases is most always passed on directly to the occupier, resulting in higher rent.  Secondly, articially inflated rents have the effect of raising the overall base value of the market, making it more expensive.

Of course, a lease is a complex financial transaction which has many variables, including term, rate, landlord funded concessions (free rent and tenant improvements).  The market is whatever the counter parties make it.  But make no mistake, financial engineering, or “juicing” is everywhere.  Given the significantly changed outlook for global office, investors will be less agreeable to paying premiums for juiced performance.  How will they know?  It’s in the leases; which, like a sample of the Liver King’s bloodwork, will clearly show the juice.