The Financial Accounting Standards Board (FASB) has been contemplating making significant changes in how both public and private companies account for leases. While the eventual outcome of these discussions is not certain, many of the proposals challenge the current off-balance sheet accounting, which commercial leases now enjoy. If companies are forced to place lease obligations and extension options on their balance sheets, the potential consequences for the many stakeholders in the commercial real estate industry may be significant:
- Some companies may simply choose to own rather than lease space. Some surveys indicate that as many as a third of the firms surveyed plan to go this route. While this would create new demand for the purchase of office and industrial buildings, it would do little to reinvigorate the leasing market.
- Commercial real estate brokers will also need to adapt to the changed marketplace as revenue from long term leases will no longer be as readily available. In the long run, the revenue loss will be made up by the increased velocity of transactions resulting from shorter term commitments but that benefit will be three to five years away, at best. It is highly unlikely that brokers will be able to simply raise transaction fees to cover this loss in the same way they did as leasing velocity decreased in the last three years.
- Leases under revised guidelines would certainly be shorter and fewer options included as part of the lease negotiations. The result would be far less certain income streams for building owners and lenders, which will likely reduce the acceptable levels of leverage available and increase borrowing spreads for commercial properties. Given the increased uncertainty of cash flow, lower leverage and increased borrowing costs, values would likely see some decline that may, or may not, be offset by the increased demand to purchase buildings.
- Shorter leases will result in less capital committed to interior space renovations by both tenants and building owners. As a consequence, there will become an increased demand for “as is” or “paint and carpet” spaces. I expect that the impact on the interior design, architecture and interior finish contractors will be significant.
Despite the good intentions for better financial disclosure, the impact of any new FASB regulations may come with some serious unintended consequences in addition to significant compliance costs. Much remains to be seen as the ultimate decisions are made over the course of the year with planned implementation anticipated in 2014. There is still is plenty of opportunity for an effective compromise.
The intent of this blog posting is to explore the potential implications of the proposed new regulations rather than discuss the intricacies of the FASB proposal. For a look at what is actually being considered, take a look at this link: New FASB Proposal.
Just a little food for thought for the Memorial Day Holiday…