A huge sigh of relief could be heard when the Financial Accounting Standards Board (FASB) voted to approve a one-year deferral of the effective date of the new lease accounting standard for nonpublic companies.
The one-year deferral comes at a time when most private companies and nonprofits are still working to comply with implementation of other new accounting standards, including revenue recognition under ASU 2014-09. This was a significant factor in the public’s push to solicit for a delay in the effective date, as the time and resources needed to implement ASU 2014-09 impeded companies’ abilities to execute on intiatives related to the new lease standard. In addition to requiring additional resources to procure, organize and analyze existing leases, many companies also are facing the need to implement new IT systems to track, administer, and account for leasing activity.
Impact on Commercial Real Estate Owners
Companies with significant brick-and-mortar footprints under long-term leases are likely to feel the greatest strain on their accounting resources as they work to meet the new information-gathering requirements and determine the proper accounting treatment for each lease.
Lessees will feel the greatest strain from the new standard. However, commercial landlords will also be affected — not so much with regard to compliance, since accounting treatment of rental income does not change, but more in terms of tenant behavior. For example:
- Incentive to purchase? The lease-versus-buy decision involves many factors. But the new complexity of accounting for leases, along with the impact on company reporting metrics, could tip the scales toward “buy” for certain businesses.
- Shorter lease terms? The requirement to record the present value of the lease obligation over the entire lease term could make some tenants prefer shorter leases. On the other hand, commercial tenants generally prefer to lock in the cost of their space long-term. Keep in mind that if renewal is probable, structuring leases with initial terms of 12 months or less will not provide relief from the new lease standard requirements.
- Double down on triple-net? Unless lessees use a practical expedient, they must carve out nonlease components (such as maintenance costs, property taxes, and insurance) from the lease payment when recording amounts. This segregation is simpler with triple-net leases, since nonlease components are already billed separately to the tenant.
How Real Estate Owners Can Help Tenants
The new standard will be complex, especially for tenants whose operations consist of numerous long-term leases of real estate and other assets (i.e., fleets of vehicles, machinery and office equipment, etc.). Landlords who demonstrate a sophisticated understanding of this compliance burden are likely to build goodwill with their tenants. Landlords should also show a willingness to be patient and responsive to their tenant’s needs.
Lessees need to start collecting the required lease information as soon as possible. Landlords can also simplify the process for their tenants by helping them locate historical lease documents (including amendments and exhibits) that can be important to the reporting process. Compliance will mean significant time and effort to implement new processes and procedures, gather and review data, and create and monitor systems. Even though the deferment gives companies breathing room, putting off implementation will only delay the inevitable.
As a commercial real estate owner or investor, your business relies on the financial health of your tenants. CRI can help you and your tenants understand the impact of this complex new standard and assist with implementation.