Posted by: BayAreaComRE | March 29, 2010

Real Estate Financing Overhaul Looming – What it Can Mean for Your Business

Real Estate finance accounting may be revamped, and the implications could be enormous for businesses in the US. The Financial Accounting Standards Board has issued multiple reports indicating the coming change, with a target date of 2012 for final implementation, should the standard be adopted.

A major part of Cushman & Wakefield ‘s CFO Roundtable is to track these types of issues; those that directly effect the bottom line of companies, large and small. The CFO Roundtable covers 13 major markets across the country, with the first event in the Bay Area kicking off at the end of 2009. The next CFO Roundtable locally is slated for this summer. The first event boasted panelists like Graham Smith, CFO of, and Hank Halter, CFO of Delta Airlines and we partnered with Accenture and Haas School of Business. The aim is to target CFO’s to facilitate a “meeting of the minds”, create a community with top finance officers in the Bay Area and connect them nationally in a casual environment. Stay tuned for more great content like this report and check out the website for more information.

From the report, “the proposed standard would require the replacement of all operating leases with capital lease accounting, triggering a shift of billions of dollars to balance sheets across North America. It is estimated that 70% of the lease value to be capitalized involves commercial real estate. The end result of a change of this magnitude will be a vast shift rippling through financial reporting, processes and metrics across all US and global industries.

Operating leases are also considered off-balance sheet obligations. As a result, the replacement of lease accounting continues to be a priority for the Financial Accounting Standards Board (FASB – which sets US standards) and the International Accounting Standards Board (IASB – which sets standards for all IFRS-regulated countries).

The reach of the new standard is vast – covering millions of lease agreements held by thousands of businesses in the US that report using US GAAP. As it is not multi-tiered, US GAAP is applied in the same manner to both public and private companies who report under these standards.

The following are some of the commercial real estate issues that might arise, taking into account changes to both strategic direction and administrative responsibilities associated with the new standard:

1. No grandfathering of existing lease obligations

Financial ratios will shift day 1 of the transition, so the measurement of current and forecast obligations will be required in advance of the standard. All remaining lease obligations on the transition date will be capitalized as a “right-of-use” asset.

2. Longer approval cycle for new leases – 2010/2011

Businesses may want to understand the economic impact for new obligations. More details are needed to complete the review of real estate portfolios.

3. Lease term drives measurement of new obligation

Businesses will seek transaction structures that minimize capital obligations. Shorter lease terms reduce the “right- of-use” asset and obligation recorded. The recognized lease term would be the longest possible lease term that is more likely than not to occur. All relevant factors must be considered, including renewal options.

4. Portfolio evaluation to optimize financial metrics

Businesses may consider restructuring their commercial real estate portfolios. Where appropriate, lease versus acquisition opportunities might be explored; lease renewal & termination dates will be integrated into the forecasting cycle earlier. The effect will be uneven across industries and corporations.

5. Capital approval process

Capital approvals will be necessary for both new obligations and the renewal/recast of existing lease obligations. 2010/2011 approvals would have both expense and capital components. Businesses may have a limit on capital funds available or set IRR targets for internal requests.

6. Measurement

The measurement of the lease obligation will likely be more onerous due to the definition of components: i.e. NPV of funds, discount rate, determination of “more likely than not” term and estimation of contingent items.  Additionally, there is a requirement for remeasurement at each reporting period based on facts and circumstances.

7. EBITDA shift

Businesses will need to change internal budgeting and tracking systems for commercial lease obligations as “rent” disappears and is replaced with interest and amortization. Internal and external EBITDA targets will require recalibration.

8. Covenants

Financial ratio and debt covenants in all agreements will need to be evaluated against the new standard – and recalibrated if they trigger breach of covenants. Renewals and recast agreements may require bank approval as additional debt. “frozen GAAP” and “rolling GAAP” definitions require different resolutions.

9. Education

The scope of change is profound. The new standard would replace 30-plus years of technical knowledge held by business managers. Competency in the new standard will be vital for all management and decision makers.”

The full report can be found below.

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