Fred Berk, Co-Managing Partner and Real Estate Practice Leader, sat down with Real Estate Finance & Investment to share more about leases and how changes in the accounting industry may have an impact.
Tenants in commercial properties need to start preparing for new rules for lease accounting that will change the way leases are classified. “Under the new right-to-use model, companies will have to reflect the liability [of leases] on their balance sheets,” said Fred Berk, co-managing partner at Friedman LLP. “It’s a completely different meth- od of accounting to what is in place right now and it will change how banks and other financial institutions calculate covenants on loans.”
The changes, which are being handed down by the Financial Accounting Standards Board and the International Accounting Standards Board, will take effect for the years after Dec. 15, 2018 for public companies and one year later for private companies. “We’re advising clients to go to banks now, before these rules take effect, and review their documents. Otherwise, they will be in default if the bank documents are not revised,” Berk added. Banks will also be incorporating these changes into their analysis and due diligence when originating new loans, he noted.
In the past, leases were off-balance sheet liabilities. “If you’re a company that leases office space, you’re likely paying a significant percent- age of revenue toward that cost. It will now be capitalized on the balance sheet and it completely changes the financial position of a company,” Berk said. “While it wasn’t reflected on a company’s balance sheet in the past, if you really knew how to read a financial statement, you would be aware of it. But now a 10-year lease will be a 10-year obligation that will be reflected.”