In the Spring 2016 Issue of National Association of Realtors magazine, Commercial Connections, in an Advocacy Article titled “A Look at Several of The Issues Important to your Business” under “Lease Accounting” there is information on the new FASB Standards that were released in February 2016. This is a reference to the Financial Accounting Standards Board, FASB Accounting Standards Update No. 2016-2 February 2016, Leases (Topic 842).
This is the first big change in something like 40 years to the standards for Lease Accounting. It does apply to all leases, not just commercial real estate leases. For companies that use GAAP accounting it goes into effect December 15, 2018. Most private companies have until 2019 for fiscal years beginning December 15, 2019 to transition to the new rules. There is a lot to digest. And I suspect companies that use GAAP accounting are working now to get their arms around this. And they may need either more accountants and/or real estate brokers to assist with gathering and organizing the data and formulating a strategy for office, industrial, and retail leases.
From NAR’s article under Lease Accounting they ask “What does this mean for my business? The new standards could harm businesses of all sizes, especially lessees and lessors of commercial real estate. With more bloated balance sheets, some companies may see their debt to equity ratios increase and find it more difficult to obtain credit, especially those with heavy debt loads or still recovering from the recession. The new standard could also complicate compliance with debt covenants or agreements between the bank and borrower, which usually prohibit companies from borrowing more than they are worth. By capitlalizing new and/or existing leases, some businesses could show more debt than allowed in their agreement with the lender, and therefore be in default of their loan. This could force some firms to put up more capital for existing loans or even have their credit lines revoked. “
“Additionally, the elimination of off-balance-sheet financing could be detrimental to commercial property owners. More frugal lessees will want less space and shorter-term leases without renewal options or contingent rents, which will decrease cash flow for property owners. Short-term rents will likely reduce the borrowing capacity of many commercial real estate lessors, who rely on lessees and the value of the property as collateral in order to obtain financing. Ultimately, property owners would be forced to increase rent rates due to market uncertainty and reduce tenant improvements due to shorter recovery periods. Conversely, this change could encourage some firms to consider buying instead of leasing commercial real estate.” We shall see what kind of weather this causes for CRE.