October 18, 2010—Commentary: Lease accounting rule would hit commercial real estate when it’s already down

By Henry H. Chamberlain

WASHINGTON POST

October 18, 2010

In response to Danielle Douglas’s article on Oct. 4, “Changing the equation: New accounting rules would require companies to show leases as liabilities,” the logic of altering Financial Accounting Standards No. 13, or FAS 13, when commercial real estate is feeling the full impact of a sickly economy is indeed being questioned by the real estate and business communities. The proposed change in the lease accounting standard will affect both landlords and tenants at a time when lending is still nearly impossible to secure.

In 2006, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) entered into a memo of understanding to develop a new standard on lease accounting. It’s another in a line of Enron-inspired accounting changes that could significantly increase costs and complicate financing in an already fragile economy. In short, the new standard capitalizes all leases and will require lessees and lessors to make projections on lease extensions and apply these projections in a complex calculation to determine the assets and liabilities to be recorded. Currently, lessees do not have to account for possible extensions.

Beyond the terrible timing of the accounting change, the new standard will fundamentally change the way commercial real estate operates. First and foremost is the impact on lease terms. Both landlords and tenants holding leases longer than 12 months will be required to apply the standard to their leases whether new or existing — no grandfathering. It is expected that tenants will no longer want a typical 10-year lease with a five-year extension option due to the debt that will need to be recorded on their balance sheets.

As Ms. Douglas mentions in her article, FAS 13 could “upset debt ratios, making it harder for companies to secure loans.” The availability and affordability of capital is paramount to the industry, and stable tenants and rents are key to accessing this capital. Katya Naman, senior vice president with Lowe Enterprises in Washington, said she thinks the shortening of lease terms will make obtaining financing more elusive and costly. “Think how hard it is to get financing now,” Naman said. “If you create less stable rent rolls, lenders will perceive risk and react accordingly by lending less or raising rates.”

Tenants that don’t want to carry a liability on their balance sheets and choose to enter into shorter leases could find it tougher to negotiate worthwhile tenant improvements. “You can amortize more tenant improvements over a long-term lease,” Naman said. “This could mean the difference of replacing only the carpet on a short-term lease as opposed to the landlord performing a complete build-out of an entire space on a long-term lease.”

Finally, the cost of implementation and maintenance to remain compliant should not be ignored. For the owner of a multi-tenant office building, each lease will need to be reviewed and the standard applied to determine the lease receivable and performance obligation liability. For the tenant, it means less favorable lease terms and higher costs.

If FAS 13 isn’t good for tenants or owners and investors, then who is benefiting from this new lease accounting standard?

(FASB is receiving comments through Dec. 15. To enter a comment, visit http://www.fasb.org.)

Henry H. Chamberlain is president and chief operating officer of the Building Owners and Managers Association (BOMA) International.