November 2010

BOSTON, MA – Impending changes for reporting commercial real estate leases may create a huge liability on your company’s balance sheet.  If your company leases office or industrial space, you need to be aware of the proposed new accounting standards that may affect current and future commercial real estate leases.

The proposed lease accounting standards, known as FAS 13 (Financial Accounting Standards 13), would require all lease liabilities to be recorded as capital leases instead of operating leases.  Currently, companies do not have to record on their balance sheet an operating lease, which essentially is a rental contract. They do have to record the asset and lease payments of a capital lease.

The proposed change means that commercial real estate tenants will have to record a commercial real estate lease as a capital lease. This includes all of the lease liability and asset, including options, percentage rent, renewal options, co-tenancies and other contingency-based payments.  Reporting your commercial real estate lease this way will make your company’s debt load appear many times bigger than what you currently report.

The U.S. Financial Accounting Standards Board and the International Accounting Standards Board may announce the new standards as soon as the second quarter of 2011. Both organizations are taking comments on the proposed changes until Dec. 15, 2010. Although reporting changes are not required until after the new standards take effect, tenants in the midst of a lease now will have to account for that lease under the new rule. The change does not grandfather any leases that exist prior to when the new standards take effect.

This will have an immediate effect on your company’s balance sheet including your loan profile to new or existing lenders, which may make it difficult to secure financing. It could also make it harder and more expensive for companies to do business.

This dilemma raises several questions that need to be answered before making a decision to lease space. These questions include;

  • Should your company buy property instead of leasing?
  • Can your company afford to show the financial implications of a long-term lease on its balance sheet?
  • Is it beneficial to negotiate a short-term lease to reduce liability and lose the financial benefits of a long-term commitment?
  • Does it make sense to renegotiate an existing lease to something more favorable under the accounting changes?
  • Is a first-right-of-refusal to renew a lease a viable replacement for an option-to-renew clause?

ITRA/The Stevens Group provides commercial real estate advisory services to tenants and occupiers of offfice and industrial space, and helps companies understand these impending changes and how they may impact their balance sheet. We also assist companies in identifying the best strategy for leasing or buying  commercial real estate under these new accounting standards.  Please call us at (617) 886-9300 to discuss you companies current and future lease situation.