Will New Lease Accounting Standards Change Your Real Estate Strategy?
Sometimes you’re sailing along smoothly, until you encounter something unexpected that forces you to correct course. For corporate real estate professionals, the unexpected encounter may have come in the form of the new FASB lease accounting standards. Beginning January 1, 2019, the new standards established by the Financial Accounting Standards Board (FASB) will go into effect for all public companies.
While an organization’s accounting department will likely experience the most impact, the new lease accounting standards will certainly affect corporate real estate (CRE) leaders as well. Here are a few things CRE professionals need to consider over the next few months.
New Lease Accounting Standards: 10 Questions CRE Leaders Should Ask
In its report, The overhaul of lease accounting: Catalyst for change in corporate real estate, PwC suggests corporate real estate leaders ask the following questions as they evaluate their strategy:
1. Does your real estate strategy support the organization’s overall goals?
2. How do your company’s real estate assets fit into its capital structure?
3. What influences your lease vs. buy decisions?
4. Does your business have comprehensive data about each of its lease obligations?
5. Have you identified current market opportunities and their impact on your corporate real estate strategy?
6. What effect do federal, state and local taxes have on your real estate decisions?
7. How does your organization manage costs of occupancy?
8. How will the new lease model impact your company specifically?
9. Does your business have an adequate system in place to collect and organize the data needed to meet the reporting and disclosure requirements of the standards?
10. Which potential changes in terms of existing systems, processes and personnel may be necessary?
Knowing the answers to these questions will help you reach the right conclusions about how best to optimize your real estate strategies.
The Impact of the New Standards on Your Balance Sheet
As part of their graduate thesis project, Timothy Robert Canon and Christina Anne Fenbert, two students at the MIT Center for Real Estate, surveyed representatives from 29 different companies across multiple industries in order to determine the effect of new lease accounting standards proposed in 2011. Canon and Fenbert asked the sample of tenants, landlords and other professionals if the proposed changes to lease accounting would have an impact on their corporate real estate decisions.
Canon and Fenbert found that while the new standards would not result in a universal change in corporate real estate strategy, they did identify the two primary factors that would influence an organization’s choice to reevaluate its real estate strategy:
● The size of a company’s operating lease portfolio relative to its balance sheet
● A company’s sensitivity to financial statement presentation
The second point is based on the fact publicly-traded businesses are under intense scrutiny from rating agencies, company analysts and investors. Since, according to JLL, over 85 percent of lease commitments aren’t included on the balance sheet, the new standards will have a major impact on how the balance sheet appears.
More specifically, balance sheets will show substantially different debt-to-equity ratios and return on assets. If you’re interested in the ability to present a more attractive balance sheet to these entities by reducing the impact of the standards on your balance sheet, modifying your real estate strategies is a necessity.
3 Ways to Optimize Your Real Estate Strategies
Should you resolve to update your real estate strategy, our partners at Visual Lease recommend implementing one (or all) of the following changes:
● Purchasing property, rather than leasing. If your organization plans to occupy most of a building for an extended period of time and the business has excellent credit and sufficient capital, it may cost less in the long run to purchase than to lease.
● Setting shorter lease terms. Due to greater lease liabilities, longer lease terms can have an increased impact on the balance sheet. Therefore, shorter lease terms may be a smarter option for your company.
● Changing payment structures. Updating lease structures to list the costs of lease and non-lease components will make it easier to comply with the new reporting requirements.
How You Can Get Ready for the Standards Update
Even though public companies are not required to adopt the new lease accounting standards until 2019, one of PwC’s most ardent recommendations is to begin preparing now. Getting a head start will help the process go more smoothly and ensure the organization captures the necessary information about existing leases and any new contracts that are signed before the standards go into effect.
PwC offers an example transition plan corporate real estate leaders can use to make sure adoption of the standards is as painless as possible.
Regardless of which aspects of your real estate strategies you choose to update in the face of the new lease accounting standards, you will be facing an uphill battle. But lease management software can make that battle less intimidating. Consider investing in an integrated solution that allows you to see all of your lease data in a single interface and empowers you with the tools to make more confident real estate decisions.