By Richard Kadzis
Lease Accounting Changes:
Big Impact, Little Preparation
UNCERTAINTY CHARACTERIZES THE CURREN T
period starting with the global economy. Even with
some encouraging signs at the macroeconomic level,
corporate real estate is confronting record-low transaction volumes, an absence of credit, air-tight capital,
devaluation, falling rents and occupancy rates, several
tranches of toxic CMBS refinancing and then some.
Now, add to the list a serious revision in lease accounting standards as proposed by the Financial Accounting
Standards Board and its global counterpart.
A study recently conducted by CoreNet Global
Research and Jones Lang LaSalle shows 99% of CRE
executives have not fully evaluated the accounting rules
changes that could take effect as early as 2012. The
survey underscores the need for CRE to align with corporate finance in approaching the proposed changes,
which apply to publicly traded and privately owned
corporations as well as to real estate and equipment.
“This means that CRE executives, whether at their
initiative or otherwise, are going to be talking a lot
more to the finance side of the house to understand
the changes and manage for the future,” according
to Mindy Berman, managing director of corporate
capital markets at JLL.
The current proposal applies only to the base
leased amount and not to common expenses such as
utilities and property taxes. Since all leases will be converted when the standard becomes effective, leasing
decisions can affect future financial statements.
Two-thirds of the executives surveyed believe the
changes will have a major or substantial impact on
corporate earnings, mainly because the new rules
would force companies to treat leases as capital, not
One expected result is that P&L expenses would
be higher for former operating leases and more similar
to capital leases today. The move would mean that at
least $1 trillion in leased property and facilities could
be added to corporate balance sheets, according to
a 2005 SEC study. Lease-intensive industries that
would be most affected are retailers, airlines and commercial banks with retail branch networks.
The survey shows the new standards have begun
emerging in stealth fashion. Until now, at least, it’s
remained a potential threat to industry shifts like less
ownership in favor of more leasing flexibility; the ability
to capitalize, then lease back and occupy, assets at less
cost; or the advantage of not carrying facilities, property
and all kinds of equipment on balance sheets.
that much shorter lease terms will result. This is
especially worth noting, with nine in 10 respondents
indicating that nearly all of their real estate leases are
structured as operating leases, implying high-volume
restructuring. By comparison, the SEC estimates
that 70% of all operating leases are for real estate.
Whichever metric applies, the need for shorter leases
could generate a mini-Y2K-like wave of transactions
and lease revisions as the standards take hold.
Both of the accounting governing bodies foresee
higher levels of financial transparency and a truer view
of corporate asset values as desirable outcomes. But
survey respondents fear a massive shock. For example, more than half have not fully considered the total
impact that the changes could have on earnings.
However, there is another possible silver lining to
the scenario. If enacted, the revised standards could
spur a new set of data needs and fees along with
higher transaction volumes due to shorter-length
leases coming to the fore.
Plus, ownership levels might increase, adding to
the transactions stream. Participating executives
were evenly split on the question of owning versus
leasing. But 58% of them either agree or strongly
Richard Kadzis is director
of membership at CoreNet
Global in Atlanta. He may
be contacted at rkadzis@
Corporate real estate executives have not fully
evaluated the accounting rules changes that
could take effect as early as 2012.
agree that they may alter the structure of leases
should they be capitalized on balance sheets.
Will it also change the way that analysts and investors consider lease liabilities when they value companies? Less than one-third said that the accounting
changes would alter those views, while fewer 22%
Regardless of the expected outcome, as JLL’s
Berman notes with some irony, “Lease accounting is
a stealth issue, one that will be nipping at our heels
at just the point when many expect the economy to
kick back into gear.” ◆
The views expressed in this column are those of the
author and not necessarily REAL ESTATE FORUM.