Moving Leases to Balance Sheets Has Landlords and Tenants Off Balance

Moving leases—real estate, equipment or otherwise—onto balance sheets has been kicked around for some time now, but an agreement recently reached by the International Accounting Standards Board and the Financial Accounting Standards Board could signal that change is actually coming.

Sources told The Commercial Observer that the initiative, which caught fire as “transparency” became a buzzword in the midst of the financial crisis, could have major implications for lessees of commercial real estate, particularly those that lease multiple or large blocks of space.

Stephanie Urbanski, a global real estate sector resident and assurance senior manager at Ernst & Young, pointed out several of these implications. They include changes in balance sheet metrics as leverage and capital ratios, decreased borrowing capacity and decisions by some lessees to buy rather than rent.

“Their current loan agreements may say that they must have a debt-to-asset value of some number,” Ms. Urbanski said. “If you’re increasing the debt balance, that gives them less borrowing capacity.”

calculator Moving Leases to Balance Sheets Has Landlords and Tenants Off BalanceShe added that what may happen is that tenant loan documents can be amended for larger tenants that may have more bargaining capacity with their banks. But buying rather than renting might not prove an option.

“If you were to buy a property as opposed to rent it, you’re probably not going to have the cash laying around to buy that asset anyway, which is why you have debt to begin with,” she said. “I’m not sure that solves your issue.”

Meanwhile, some say that the proposal from the understaffed and overworked groups is perhaps not as well thought out as it should be.

Seth Molod, a partner at Berdon LLP, said that he had heard about the two boards—FASB and IASB—releasing a joint exposure draft about proposed changes to lease accounting “six times,” and that the draft released in 2010 leading up to the groups’ current joint technical plan wasn’t well-received.

“They didn’t put their heads through it, and there were a lot of really negative comments,” Mr. Molod said. “They’ve done a little bit better job in the last iteration of this thing.” These improvements, he said, include changes to the approach of income recognition and considering leases on a straight-line or accelerated basis.

For the moment, most observers are waiting to see what’s contained in the next exposure draft due from the two groups. This was originally expected in the fourth quarter of 2012. “Now they’re looking at the first half of 2013,” Ms. Urbanski said, noting that the date change occurred within the past month or so.

“We understand there is something coming out this fall, but we haven’t seen anything substantive,” said Charles Achilles, the Institute of Real Estate Management’s chief legislative and research officer. “There have been a number of exposure drafts over the last two years.”

Mr. Achilles said that IREM is opposed to anything that would change how leases are currently being considered—that is, as an operating expense. He said that real estate has been operating the current way for decades, and that moving them to balance sheets would, out of sheer necessity, cause lessees to shift how they lease space.

“Major players like a Walgreens, where they’re leasing a lot of property, will probably end up going short-term on leases because they don’t know what tomorrow will bring and they will have to carry those leases as a liability on their balance sheet,” he predicted.

From her perspective, Ms. Urbanski said that shorter leases, at least for larger companies with many different leases, probably wouldn’t happen. “I don’t see the accounting implications of this driving a significant business decision,” she said.

Mr. Achilles pointed out that IREM is currently part of a coalition with the U.S. Chamber of Commerce, which issued a letter on Sept. 10, 2012, about the matter.

IREM’s official position on the lease accounting rule changes, adopted in October 2010, reflect Mr. Achilles’s statements about corporations and go further to express concerns about the potential impact on the overall economy.

“IREM is concerned that the new lease accounting proposal will be detrimental to our nation’s economy by reducing the overall borrowing capacity of many commercial real estate lessees and lessors,” the position statement reads. Also, IREM is opposed to lease accounting standard changes that would treat the income producing real estate business as a financing business on company balance sheets. Such a step would not accurately depict the unique characteristics of the investment real estate sector and in turn discounts the usefulness of the industry’s financial statements.”

But for now, lessees could have bureaucratic red tape—and hence time—on their side. The delayed exposure draft would have to be issued, followed by a period for public comment and, finally, a block of time to allow for the implementation of lease accounting rule changes. “Considering that they have to release it for recomment and then come up with a final proposal—then you’d have a period for which to have an effective date,” Ms. Urbanksi said, “you’re looking at a long period.”

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