Manhattan Commercial Real Estate, in a few words.

The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) recently agreed to consider modifying their proposal so that leases could be classified as either “finance” or “other than finance” contracts — similar to existing categories of capital or “operating” leases.

The Financial Accounting Standards Board (FASB) is scheduled to issue the final version of its lease accounting overhaul this summer, so we will be patiently waiting for the summer, while wondering how this may impact the real estate brokerage community and the commercial real estate community in general.

As a reminder, under current accounting policy, most companies record their leasing costs as an expense — not as a liability.
Under the proposed new standards, companies will be required to record operating leases as a “right of use” (ROU) asset and as a corresponding liability (for expected lease payments) on their balance sheets.
Under the proposal, all leases of real estate and of equipment would have to be capitalized on a company’s balance sheet.
At the end of the day, this might seriously impact a company’s ability to borrow money.
Why?
Because if you sign a 5 year lease for $220,000 of yearly rent (example 10,000 SF at $22 psf), your liability for the 5 years will be around $220,000 x 5 = $1,100,000 and this without taking into account any increases or other rent related expenses.
So basically, the year you sign this brand new lease, you get a 1.1 M$ liability on your balance sheet. This liability is getting reduced over time as your lease is getting closer to it’s expiration date, but still… for your banker it will look like you just borrowed 1.1 M$ that you will be repaying over the next 5 years…

The boards also appear to have softened their views on how companies should account for renewal options and other factors that lead to variable lease payments, agreeing to raise the threshold for when lease renewal options should be included in the liability.

Although FASB appears to be backtracking somewhat on its original proposal, it is reportedly still planning to move forward with rules that would include the amortization of costs for property leases. FASB is scheduled to issue the final version of its lease accounting overhaul this summer.

As a commercial real estate Advisor, I remain concerned that the new rules would have far reaching consequences for an array of industries, the banking system and capital and credit markets.

I believe that the proposal will discourage businesses from leasing commercial space, which would be the worst case scenario, or prompt them to press for shorter-term leases, which might end up being more likely. Such a development would complicate financing for commercial property owners, since their ability to obtain financing depends significantly on their ability to sign tenants for longer term leases. I also believe that in return, it will generate some serious purchasing activity, as buying a commercial real estate property might become more attractive than leasing it.

The new lease accounting standards could also severely impact the financial services sector, including pension funds that hold commercial real estate investments on behalf of millions of Americans

Is that something that we want during a recession? Not sure, but I will leave it to you to make your own mind…

Peter Videv is a Senior Advisor with Sperry Van Ness in New York City.

Peter Videv and Sperry Van Ness are not qualified to provide, and have not been contracted to provide, legal, financial, or tax advice, and that any such advice regarding any investment by the recipients must be obtained from the recipients’ attorney, accountant, or tax professional.  Information contained herein is believed to be accurate, however, Sperry Van Ness does not warrant it and recipient should conduct their own due diligence.