New Accounting Rules Affect Short-Term Leases

WASHINGTON, DC-Next month, the US Financial Accounting Standards Board and its counterpart, the International Accounting Standards Board, are expected to issue an Exposure Draft of lease accounting changes. The rules, which will not go into affect before 2012, or possibly 2013, are for the most part a theoretical challenge lying in wait--but in some cases they are already starting to impact tenant behavior. At least that is one possible extrapolation from some of the most recent leasing data for the area.

In brief terms, there are two big changes companies have to think about under the new rules, Jones Lang LaSalle’s Mind Berman explained to GlobeSt.com in an earlier interview. One is that all lease obligations are going on the balance sheet. In other words, all rent obligations will be capitalized as a form of debt financing, which essentially means their debt load will increase--possibly by a significant amount depending on the circumstances. Currently that is not the case.

Second, the occupancy expense that runs through the P&L will increase substantially, but companies will no longer recognize rent expense. Instead it will be an amortization of an asset they have. Given how complex the rules are, tenants will naturally want to keep lease terms as short and as flexible as possible, Berman concluded.

Of course, tenants have been demanding--and receiving--such flexibility ever since the start of the current down cycle, but primarily for business purposes. This is still the case even with the glimmers of a recovery, Jones Lang LaSalle’s Research Director, Scott Homa, tells GlobeSt.com, with typical renewals being inked in the three-to-five-year range. JLL estimates that 70% of all DC-area transaction activity in 2010 has been concentrated in renewals, most of the short-term variety.

"Some of this is a function of uncertain business plans and the favorable economics of remaining in an existing space, rather than making the capital expenditures necessary to relocate," Homa says. But accounting rules are having an impact on real estate decisions as well, he says. "For example, over the past two years, unlike law firms and associations, publicly-traded companies were reluctant to list sublease space on the market, because once they did, there would be an immediate hit to their balance sheet," Homa relates. "Any new regulation has the potential to impact the decisions tenants adopt in the future."