NEW YORK CITY—The businesses of real estate firms—tenants are looking into creative ways to comply with the new GAAP lease accounting standards which will require a significant undertaking for many companies. In a GlobeSt.com interview, Anchin, Block & Anchin accounting firm partner Zurab Moshashvili reviews one example of what’s changing and its effects on CRE.
As of January 1, under the generally accepted accounting principles or GAAP established by the Financial Accounting Standards Board (FASB), publicly-held companies will be required to present their real estate liabilities and assets in the balance sheet of financial statements instead of in the footnotes. Private companies have another year to comply. The new rules were designed to increase transparency, so investors and lenders can make better informed decisions.
GAAP accounting, which is governed by the US is required for SEC filings. International financial reporting standards (IFRS) are not governed by a US body and are not required of domestic public companies.
The new standard on lease accounting will apply to tenants who are occupying spaces, such as office buildings and retail buildings. This will impact how those tenants negotiate leases with real estate companies and with the landlords says Moshashvili.
He explains that the dollar amount of liabilities represents the future cash outflows that a company would have to pay to the landlord for rent. This is offset by the asset, or the value of the right of the company to use the space. “The balance sheet is now being inflated with a large asset and large liability,” he says.
What’s at stake is how the new rule will affect the financial metrics or income statements of the company, according to Moshashvili. He points out since equity is assets minus liability, the new accounting would affect leverage metrics such as the debt to equity ratio, the liquidity metrics such as the current ratio or the quick ratio, and debt performance metrics such as the return on assets. And the impacts would likely be negative ones.
“If you think about a publicly-traded company, when analysts are looking at the financial statements of these companies and all of a sudden some of these ratios are not looking as good as they used to because of this leasing standard,” says Moshashvili. “Wall Street doesn’t like certain ratios which appear to be inflated or appear to be more negative than they historically used to be.”
Large publicly-traded companies have multiple leased locations across the country. Anchin is seeing companies wanting ways to reduce their assets and liabilities, so their metrics will be less negatively affected. One of the ways to do this is shortening lease terms.
Moshashvili has observed tenants considering reducing 10-year leases to five-year or two-year leases. But he adds a shorter lease term creates a certain amount of uncertainty for the real estate owner, which can negatively impact valuations. Further complicating the process, the new standard does not only apply to real estate. It extends to any lease longer than 12 months. Cars, machinery, even copiers are just some of the other possible examples of what could now end up on companies’ balance sheets. Software upgrades, IT updates, personnel and accounting costs to comply with the new standard could also affect the bottom line.
“That’s what I meant when I said financial statements of commercial real estate companies are not going to be impacted but the way they do their business will be,” he says.