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Monday, May 2, 2011

By Rand Stephens (Houston)

Among the many regulatory changes being discussed by FASB and IFRS to improve financial transparency, the ones being discussed impacting lease accounting, may dramatically change the real estate industry.

Under the new proposed rules, companies using Generally Accepted Accounting Principles (GAAP) will have to capitalize leases for their facilities. This means that all rents over the term of a lease, including operating expenses, renewal options and contingent rents, will become liabilities on the balance sheet and may dramatically affect financial ratios, loan covenants and EBITDA.

Avison Young published a white paper last year on the topic that has more detail regarding the origianl proposed changes. Since then, FASB/IFRS have had over 800 responses from industry stakeholders who have expressed the need for major revisions and clarification of many of the proposed changes. Currently, FASB/IFRS is pushing to absorb this feedback, make their recommended updates by June of this year, and then move forward with a proposed timeline for implementing these changes.

It appears that having to capitalize a lease from an accounting standpoint is definitely happening. This will impact any lease that is longer than 12 months. As a result, companies may move to shorter term leases to minimize the reportable liability. This effect is potentially devastating to real estate values as the shorter term lease adds more risk to the investment and will surely show up in loan underwriting. In addition, there will be a significant cost to companies to change their financial reporting processes to retroactively convert operating leases to capital leases and to provide more required detailed quarterly financial reports for their leases.

The current GAAP rules for lease accounting have been in place for decades and are clearly understood by corporate america, lenders and wall street analysts. Personally, I really question the need for reform in this area. It seems as though there will be an inordinate amount of cost for very little gain in improved transparency. Why burden corporate america with non-productive costs at a time when our country needs more job creation?

What brought down the house was a completely unregulated derivatives market...let's focus on fixing that!

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