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Lease Accounting Rules Spell Commercial Trouble

By Robert Freedman, Senior Editor, REALTOR® Magazine

Just as commercial real estate is clawing its way back to slightly better conditions than what it’s faced in the last couple of years, two accounting boards are thinking about making some rule changes that could deal a signifcant blow to companies that lease space and to those that own the property.

The two boards are the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). The rule changes have to do with how lease contracts are treated for accounting purposes. Right now, lease contracts are treated as operating expenses of the companies leasing the space. Under the change, the companies would have to show the full value of these contracts on their balance sheets as a liability.

Why does this matter? Imagine you’re a company with a lease contract worth, say, $250,000. That includes the rent you’re paying on a square-footage basis, the number of months in your contract, and any contingent rents or other factors you add in. Suddenly, you have to show this $250,000 on your balance sheet as a liability. If you’re not a very big company, that $250,000 can throw your balance sheet way out of alignment, making it hard for you to get financing. It could even put you in technical default on your existing line of credit, if you have one. It might be that the terms of your line of credit require you to maintain a certain asset-to-liability ratio. Well, suddenly you no longer meet that ratio.

To be sure, the rationale behind the potential change is a good one: the accounting boards want to increase transparency and help investors get a better picture of exactly what a company’s assets and liabilities are. But the change, if it occurs, would have the unintended consequence of hurting a huge percentage of the commercial market. By some estimates, $1.3 triilion in value of these lease contracts would end up on company balance sheets.

It wouldn’t just be the companies that lease space that would be hurt. Property owners would be hurt, too, because their tenants would want to renegotiate their leases to shrink them down, not just in the amount of space they lease but in the length of the terms. They would also want to eliminate contingent rents and other terms that increase the size of the contract.

Not only would these smaller contracts hurt property owners’ cash flow, but, because the value of the contracts would shrink, they would have a harder time themselves getting financing, because their assets are smaller.

NAR has let the accounting boards know of its concerns, and it will keep up the communication with the boards’ staff. If worse comes to worst, NAR and other concerned groups could go to Congress. The accounting boards are independent bodies, but Congress, if it shares industry concerns, can certainly help let the boards know the changes should be revisited. The accounting boards want to finalise their rules next year, around summer.

You can learn more about what’s happening in the video above. More information is on REALTOR.org, too.

Robert Freedman

Robert Freedman is manager of multimedia communications for the NATIONAL ASSOCIATION OF REALTORS®. He can be reached at rfreedman@realtors.org.

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