Panel Mulls New Lease Accounting Standard

MetroWire Media | Real Estate News
| April 10, 2011

CoreNet Global sponsored a panel discussion to add some clarity to the muddied issue of lease accounting for accountants and real estate professionals. Bill Early, senior vice president with Copaken Brooks, hosted the event and along with four area experts explained how capital leases will replace operating leases and how commercial real estate (CRE) might be affected.  In an effort to align, FASB and IASB are cooperating in writing and adopting the new standard. The schedule at present calls for adoption in June of 2011 with 2013 implementation. All leases in existence as of the adoption date are affected. Estimates are that 70% of the lease value to be capitalized as a result of these new standards is commercial real estate, grabbing the attention of accounting profession and now real estate tenants, investors, owners and managers.  The new standard will affect all publicly traded companies as well as private companies using GAAP.

The panel discussed the much-anticipated changes which introduce significant complexity to lease accounting as it moves from the income statement to the balance sheet. This is especially true for organizations with broad national or global real estate portfolios.

Randy Kancel, MAI, MBA, senior vice president with UMB Bank, presented his outlook from the banker’s point of view. “Bankers recognize, or should recognize, that the metrics utilized over the last 30 years will likely give way to new measures, and it may not be an entirely smooth process. To make this process as smooth as possible, borrowers and lenders should start having a discussion in the near future concerning FASB 840 and the effects it will have on balance sheets, income statements and loan covenants. It will be an educational process for both lender and borrower.”

Tim Wilson, Regional Industry Partner for BDK National Construction & Real Estate Group, presented the public accounting point of view. “FASB has revised the proposed standard to exclude renewals which will help simplify this complex issue.  Inconsistency will exist in the way the lessee’s incremental rate of borrowing is determined.  Contingent rents and impairment are issues that will add to the complexity of the new standard. Lessor accounting will rely on either performance obligation or derecognition, but there may be an exception for IAS 40 Fair Value Reporting. In the instance of a sublease the leaseholder accounts for the lease using the lessor model while the sublessee accounts for the lease using the lessee model. Most real estate lease and financing transactions require some adherence to GAAP so lease accounting will broadly affect CRE.”

Kenneth Jaggers, MAI, FRICS – Managing Director of Integra Realty Resources – Kansas City/St. Louis, presented the institutional investor’s perspective of changes to lease accounting. “Institutional investors seem to have a dual approach to the changes in lease accounting. On the debt side, institutional investors are anticipating lower LTV’s and possibly lower returns in the short term. Deals will become more complicated, but by and large institutional debt has not given the changes significant consideration. Equity investors anticipate that balance sheet pressure may make the tenants of existing credit-tenant lease deals the most likely buyers. This may free capital for redeployment as institutional investors continually monitor their debt and equity allocations.  Finally, there may be a fair value exception for owners, but requirements of the tenants will drive changes in the market.”

And Mark Schieber, Controller for Waddell & Reed Financial, Inc., brought the perspective of a major office tenant. “The proposed changes in lease accounting could have significant impacts on a company’s balance sheet and income statement.  The balance sheet will increase as assets and liabilities are recorded that reflect the present value of leases.  Each Company will need to evaluate the impact that this change will have on its financial reporting. This could also impact such things as debt covenants and the credit rating of the company.  Management will also need to evaluate the resources that will be needed to comply with these changes. These resources could include additional staff or additional software and hardware to track the data.”

Bill Early, senior vice president, Copaken Brooks, SIOR, CCIM, SLCR, discussed the likely reaction by tenants. “We are anticipating a more onerous lease approval process as lease transactions will have significant impact on a tenant’s balance sheet.  Retailers will be most affected by the change in standards given the sheer volume of leases. However, office and industrial users will need to consider balance sheet changes as well.  The tenant’s business strategy will still dictate the financing solution.  I can see firms looking for ways to reduce their length of term, but I think this has always been the general case.  Shorter terms and the elimination of specific lease renewal options may be an immediate reaction to the change in lease accounting, however, companies will still need enough term to amortize tenant improvements.”

One thing they all agreed on: Implementation will be complicated and costly.