Study: Costs Linked To Proposed Lease Accounting Changes Could Harm Economy, CRE Values
Rule Changes Could Impact Corporate Borrowing Costs And Shave Up To $15 Billion In Property Values
Real estate businesses and property values could be adversely affected by the new accounting standards -- and the cost of complying with them -- according to a report backed by a coalition of real estate and business groups.
As international rule makers prepare to release another draft of proposed accounting changes that would require companies to capitalize real estate and equipment leases, a report warns that current proposals would impose huge costs on businesses, costs that could potentially offset at least 190,000 jobs, slowing U.S. economic growth and damaging the recovery of the commercial property sector.
Under a best case scenario in the report issued by Chang & Adams Consulting, the current proposal could increase liabilities for U.S. public companies by $1.5 trillion, with more than $1.1 trillion of that attributable to balance sheet recognition of real estate operating leases and the remainder coming from leases liabilities of equipment and other leases.
The accounting changes would result in higher spending and increased cost of capital for companies to comply with the new standards. Using an input-output economic analysis based on estimates using regional economic multipliers, the study reported the increased cost of compliance would result in the offsetting loss of 190,000 U.S. jobs in a best-case scenario and in the worst case, 3.3 million jobs. The study also reported the cost of compliance could lower U.S. GDP by $27.5 billion a year. The study was commissioned by the U.S. Chamber of Commerce, Real Estate Roundtable, NAIOP, Commercial Real Estate Development Association, NAIOP Inland Empire Chapter, NAIOP Southern California Chapter, the National Association of Realtors and the Building Owners and Managers Association (BOMA) International.
According to BOMA, the objective is to ensure that the costs and benefits of the proposed lease accounting standards are thoroughly vetted and that the analysis includes a thorough consideration of the economics of commercial and industrial real estate leasing and development, so that changes "do not distort market behavior and cause damage to both the real estate market and the national economy."
"A failure to fully understand the economic ramifications of these accounting changes or to address these issues may harm businesses that own, invest, or rent commercial real estate or use leases for other purposes, from office equipment to construction machinery," said BOMA International Chair Boyd R. Zoccola, executive vice president, Hokanson Companies Inc.
Under the best case, public companies would face $10.2 billion in added annual costs from higher interest on borrowing. In the worst case, companies would reduce debt by nearly $174 billion annually, and lessors would lose $14.8 billion in the value of their commercial property.
Other effects, such as higher rents, further reduced property values due to shortened lease terms, administrative costs and problems resulting from obscured financial reporting, have not been calculated. Moreover, the Chang & Adams study did not attempt to estimate the impact from the recognition of non-real estate operating leases.
The report comes as the International Accounting Standards Board (IASB) and the U.S.-based Financial Accounting Standards Board (FASB) are preparing a new exposure draft on the proposed changes. The boards, which are tentatively scheduled to hold joint meetings next week on Feb. 27-29, expect to release the revised draft for public comment during the second quarter.
The FASB and IASB decided in July to issue a new exposure draft on the proposed new standard, first released in August 2010, in response to the heavy volume of complaints from business groups about the rule changes.
The delay in issuing the new standard has worked to the advantage of CRE functions for lessees, allowing an extra year of planning and improved preparation for the transition, according to a February business briefing on lease accounting by Cushman & Wakefield.
"This is truly a benefit as many companies and CRE functions have not had time to date to consider the effect of these changes on their lease processes and financial reporting," according to C&W.
While no one can predict whether the new standard will influence the length of term, purchase considerations and rent structure of lease agreements going forward, "it is virtually guaranteed that the processes necessary to maintain a strategic real estate portfolio or occupancy strategy will be more complicated, will require more sophisticated data bases and will introduce more steps into planning and approval cycles across CRE departments globally," Cushman & Wakefield said. "CRE will find itself front and center in the changes ahead."
The rule makers tentatively signaled at their meetings last October that they would exclude lessors and owners of investment propoerties from the proposed rules. However, CRE and business groups are concerned about the capitalizations of lessee lease arrangements as "right of use" assets on the balance sheet with a corresponding liability, and the increased complexity of measuring lessee lease expense for financial reporting.
While the goal of the changes is to improve financial reporting, the proposed "one-size-fits-all approach would have a considerable negative impact on the business operations of the majority of firms that faithfully represent their finances," according to the study.
While published comments to date have focused primarily on the accounting and administrative burdens that would result from the proposed standard, requiring lessees to recognize hundreds of billions of dollars in new liabilities would also alter the manner in which publicly traded companies manage their operations and finances.
"The capitalization of operating leases would impact a broad number of financial metrics that are used by investors, causing a number of firms to violate their lending covenants and retarding their ability to acquire new credit," the Chang & Associates study said, adding it would force firms to cut spending and cause losses in real estate value.
"Given the significant negative economic consequences that we project, we recommend further critical studies of these issues," the report said.
Courtesy of CoStar
|Posted - 3 days ago