Unless you’ve been ignoring the news, blog posts, or have generally been living on a rock on a deserted desert island in the middle of an ocean somewhere, you have probably heard that the regulator/watchdog that is the Financial Accounting Standards Board (or the FASB for brevity’s sake) issued it’s long anticipated Accounting Standard update last year. While there was an initial furor of press coverage, substantive analyses went by the wayside given that implementation wouldn’t occur until December, 2018 at the earliest and December, 2019 for certain types of companies. Why do today what you can put off until tomorrow…
Despite their initial procrastination, the deadline for compliance for anyone who leases property is fast-approaching. In addition, certain big-ticket changes called for in the standards require companies to start thinking about their lease footprint now in order to implement mission critical business plans for the future. While the FASB leasing standards update will mainly affect your clients, as a CRE owner or manager certain provisions may create changes in the types leases and affect long term demand for your portfolio properties. With that in mind, here are a few key facts Commercial Real Estate lessors need to know about the FASB leasing standards update.
The biggest change under the new FASB standards comes from how companies record the financial impact of a lease payment on their balance sheet. Currently, the payment your tenants provide on the regular are reported on their annual tax filings as an expense item, not affecting their balance sheet, or annual reflection of total debts and liabilities.
However, in reality leases have distinct terms with benefits, and drawbacks, for payment, non-payment and varying lease lengths that help lock in lower rates or provide other upsides. The new update more accurately reflects this scenario, requiring companies to report the total balance of their outstanding lease payments under the term of the lease as a liability on the balance sheet, offset by the asset that is the right to use the premises.
These changes do have a length requirement however. Leases under 12 months in duration will not be treated as rights and obligations, and will be allowed to be listed as expenses, similar to the current accounting methods.
As a landlord or commercial real estate professional you may be thinking this is all well and dandy, but it doesn’t sound like there will be much impact to the way you do business. Owners of real property will still record their income from lessees as profit and note their individual properties as assets on their balance sheets. It’s the FASB Standards Update’s impact on how your clients will be negotiating, and which terms they’ll be asking for more frequently, though, that will present major obstacles to the way you’re used to doing business.
For starters, given the 12-month duration limit, tenants may have a greater incentive to negotiate for shorter lease terms in order to reduce the impact of a long lease value on their debt to income ratio. Shorter lease terms present stability and growth issues and more frequent renewal negotiations.
On the topic of renewal, those looking to get around the lease duration with automatic options for renewal should think again. Leases with these types of terms will be counted as having a longer length with their entire value over all renewal periods to be accounted for. CRE professionals should also look for more contentious lease negotiations as clients seek to retain familiar terms and incentives, despite lowered lease lengths.
With these changes, it’s critical that CRE professionals have the tools in place that help take the sting out of lease tracking. Renewal terms, financial insight on a tenant’s credit worthiness and critical communications will be more important than ever. For property managers and owners looking to get ahead of the curve, consider contacting Quarem for an analysis of how our line of property management software solutions can play a key role in maintaining and growing your commercial real estate empire, despite the changing landscape.