Legislative Update
Vijay Yadlapati, NATIONAL ASSOCIATION OF REALTORS®
Associate Commercial Policy Representative
Proposed Lease Accounting Rule Changes Present Challenge to
Commercial Real Estate
Just as the frozen commercial real estate credit markets are
beginning to thaw, newly proposed accounting rule changes
could be the iceberg that sinks any hope for improved commercial real estate lending conditions. Last summer, the Financial
Accounting Standards Board (FASB) and International
Accounting Standards Board (IASB), which are independent
bodies that set accounting standards, proposed lease accounting
changes that would bring nearly $1.3 trillion in leased assets
back onto companies’ balance sheets.
If enacted, the changes would require companies to use a
right-of-use accounting model where both lessees and lessors recognize assets and liabilities arising from lease contracts, resulting in the elimination of operating leases. Current
accounting rules allow many businesses to classify leases
as operating expenses, which do not appear on their balance
sheets. While FASB and IASB believe the proposed changes
would improve transparency and give investors more consistent
and concise financial reporting, NAR is concerned
that these changes will hurt the financial stability of many businesses and prolong our nation’s
economic recovery.
If this proposal is ratified, businesses of all
sizes that lease commercial space would see their
balance sheets grow, and some companies may see
their debt-to-equity ratios increase. Subsequently,
they’d find it more difficult to obtain credit, especially those with heavy debt loads or still recovering from the recession. The proposed accounting
changes could also complicate compliance with
debt covenants or agreements between the bank
and borrower, which usually prohibit companies
from borrowing more than they are worth. By
capitalizing new and existing leases, some businesses could show more debt than allowed in their
agreement with the lender, and consequently be in
default of their loan. This could force some firms
to put up more equity on existing loans or even
have their credit lines revoked.
In addition to negatively impacting commer-
cial real estate tenants, the elimination of off-
balance-sheet financing would be detrimental to
commercial property owners. More frugal lessees
would want less space and shorter-term leases
without renewal options or contingent rents in
order to shrink their balance sheets, which would
decrease cash flow for property owners. Also, these smaller
contracts would diminish the value of commercial properties
and therefore reduce the borrowing capacity of commercial real
estate lessors, who rely on leases and the value of the property
as collateral in order to obtain financing.
