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Big Changes Ahead: Impact of the New Accounting Rules on Leases

By Maureen Kelly Cooper, Senior Managing Director

Historically in the Dallas-Fort Worth market, most commercial real estate leases have been structured as full-service-plus-electric, which means the tenant pays the rent inclusive of operating expenses and taxes, and annually pays any increase above a base year (typically, the first year of the lease). A triple-net (NNN) lease structure shifts responsibility for the ongoing expenses of a property (including real estate taxes, building insurance, and maintenance) to tenants, who also cover rent and utilities.

Although we have seen a sharp increase in the use of triple-net lease structures in certain North Texas submarkets, it’s still not the norm for the entire region. With the impending change in FASB standards, though, that should change, as tenants will benefit on the balance sheet when they structure a NNN lease.

There is no difference from a cash perspective, but the new accounting rules require that costs that contribute to securing the asset (like insurance and taxes) be included in lease payments, if they are included in the fixed payments due to the lessor. Comparative reporting will be required beginning in 2019 to reflect the changes from 2017 and 2018 financials, so the impact of lease structuring today is critical.

As an example, let’s look at a company that has a 10-year lease for 70,000 rentable square feet (RSF) at $35 per square foot, with $5 per foot in operating costs and $6 per foot in taxes and insurance expense. A full-service lease would have $3.2 million more of lease liability reflected on its balance sheet in year one than a NNN lease. That’s a 23 percent increase in lease liability.

Here’s the comparative reporting:
Chart_Maureen Impact of New AccountingAlthough the new rules achieve FASB’s objective of  including all leases on the balance sheet, they have not eliminated the fact that all leases are not treated the same for balance sheet and income statement reporting purposes. Understanding a company’s financial objectives at the outset, and structuring leases accordingly, can have a huge impact on a company’s financial statement presentation over the long term.

 

web 1-8378Maureen Kelly Cooper is a senior managing director within Cushman & Wakefield’s corporate finance and investment banking team. Contact her at maureen.kelly@cushwake.com.

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