New Accounting Rules- Shorter Term Leases?
Banking institutions, financial service firms and other enterprises may have to take on new leasing negotiations. New rules regarding capital reserves against liabilities are going to be in place. A Landlord -Owner can expect some of these types of organizations to negotiate leases with shorter terms and maybe fewer renewal options. This can provide some uncertainty for owners as to how they are going to manage assets with shorter lease terms for tenants.
Capital reserves must increase by 5% on a balance sheet. If a firms lease obligations total 50 million annually, then their capital reserves would increase by 5 percent, or $2.5 million, to cover the liability. To minimize tenant turnover, the landlord will need to think more strategically regarding improvements and amenities to the property to retain tenancy.
Example: Capital reserves to be required
A financial institution that has a 3 yr term lease in place with $1M in rent and $3M of liabilities, they would be required to have at 2X the liabilities $6M in capital reserves.
Negotiations on Office Lease Options
Building owners will experience accounting changes regarding lease extension options. This will require the existing tenant to review those options more carefully. If a lease offers a tenant a better deal or discounted lease rate with a lease extension at the end of the term, the “economic incentive” could impact how the lease is classified beginning on Day One.
If a tenant signs a 10-year lease with two five-year renewal options that carry an incentive, such as a 95 percent of market rental rate during the extension period. Even though the lease is technically a 10-year lease, it could be viewed as a 20-year lease for businesses’ accounting purposes if it there is a “good chance ” that the options will be exercised.
Within the new regulations, corporate real estate users will have to determine whether their office leases qualify for the finance or operating lease accounting treatment. This will require their assets and liabilities to appear on their balance sheets. Tenants may need additional time for lease negotiations because they have to bring additional people into the process. An owner can expect possible delays so are advised to start the lease negotiation process as early as possible.