There are changes afoot in the world of accounting dealing with how companies should treat their leases – for both lessors and lessees.  Those changes will have an immediate impact on the sale of investment properties.  There are several areas where the impact will be manifest, including:

  1. Tenants may be incented to sign shorter leases;
  2. Tenants will be less likely to sign renewal and expansion options into their leases; and
  3. Corporate users may find it more favorable to buy than to rent properties they wholly occupy.


What is the goal of this effort?  FASB is hoping to eliminate off-balance sheet financing and to bring their treatment of leases into alignment with IASB, or the International Accounting Standards Board. Corporate analysts and investors claim that re-categorizing operating leases will give a more accurate assessment of a company’s liabilities, and provide greater transparency globally when comparing financial statements.

The new guidelines will eliminate operating leases, as they were defined by FASB in Statement 13 in 1976, and treat all property leases as a form of financing, i.e., ensure that all leases show up on the lessors and lessee’s balance sheets.   Whether on the lessor or lessee balance sheet, the asset / liability will be valued at the PV of the minimum lease payments, discounted at the lessee’s borrowing rate (cost of capital).

Why is this so significant?  FASB claims that leasing activity in 2008 was valued at $640 million, but industry experts claim that the current volume of operating leases is over double that amount for U.S. companies alone, and almost $1 billion of that is real estate related.

FASB is expected to issue an “Exposure Draft” of their proposed rules by early 2011.   There will be a comment period, and then FASB is expected to issue their final rules in late 2011, for an effective date of 2012 or 2013.  Existing operating leases will not be grandfathered, so the immediate impact for space users is that their balance sheets could be negatively impacted in a big way through higher debt-to-equity ratios, and lower interest-coverage ratios.

With shorter leases and diminished balance sheet strength among many tenants, lenders will find it difficult to underwrite properties to the same levels they would have before the accounting changes.  Real property loan underwriting is only now starting to recover from the 2007-2009 meltdown cycle, so another hiccup in the system will be disruptive, even if only for an adjustment period of a year or two. Consequently, property values will experience a continued phase of bid-ask uncertainty as investors and lenders recalibrate to the new accounting paradigm. The increased uncertainty over valuations will put a bit of a damper on property trading velocity between investors, just as it did during the financial crisis of 2008-09, but not anywhere near the same degree .   If some corporations find it beneficial to buy their net leased facilities, it could provide an initial boost to one sector of the investment market, but over the long term it will make net lease property investors less active buyers, since they will not see as many of the long-term credits their investors require.

-Mark De Riemer

Mark T. De Riemer is Senior Managing Director of Investment Services at NAI Global New York City, and is a member of the Investment Services Group.