Whether you own or lease commercial real estate in the Treasure Valley or anywhere in the U.S., over the next several years new rules will redefine how properties are bought, sold, leased and accounted for on financial statements.
Changes on the Horizon
For over a decade the FASB (Financial Accounting Standards Board) has been re-evaluating the accounting rules for equipment and real estate leasing. Under the current guidelines, many companies that lease commercial real estate classify these arrangements as operating leases. The lease is recorded as an expense on the company’s profit and loss statement, and there’s no corresponding asset or liability on the company’s balance sheets. This is advantageous for companies as it strengthens key financial ratios and improves their return on assets.
This changes starting in 2018. Under new FASB rules, public and non-public companies will have to show virtually all of their new and existing commercial real estate leases as capital assets on their balance sheets. Some leases may even be classified in a way to reduce profitability. Further, companies will have to re-state their previous years’ financials to show comparative information.
For Companies that Lease Commercial Real Estate
From an operating standpoint, companies need to immediately start reviewing their existing leases. Those that offer special incentives to renew the lease or purchase the property may be classified in ways that weaken the company’s balance sheet. Leases that bundle insurance, tax and maintenance payments in with the rent payment may also result in less than favorable financial treatment.
Acting now to review existing leases gives time to make smart decisions to re-negotiate leases or even purchase property while interest rates remain at historic lows.
Perhaps the biggest impact of the rule changes will be that one of the primary advantages of leasing real estate – keeping it off the balance sheet – will disappear. Instead, new lease vs. buy decisions may be more dominated by cash flow considerations.
The new rules will not change one important advantage to leasing. For companies that can’t purchase a property for cash, leasing will avoid the need to go through the extended process of securing separate bank financing.
For Commercial Real Estate Landlords
What makes these rule changes of urgent concern to landlords is that today’s prospective tenants may be unaware of how the upcoming revisions could affect their business. Landlords that are well informed will be able to act as a guide through the thicket of new rules and gain competitive advantage.
Another outcome of the changing rules may be increasing requests from tenants to re-negotiate their leases. Those leases with options for tenant purchase may get particular scrutiny as they could have the most negative impact on tenants’ financial statements.
Expect more requests from present and future tenants to break out ongoing operating costs like maintenance, utilities and taxes. While not impacting cash flow, being able to account for these expenses separately from the real estate lease can improve the tenant’s balance sheet. Triple net leases may well become the norm.