Lease Accounting Implications for Commercial Landlords
Starting in 2019, we will see new US GAAP lease accounting standards push long-term leases on to the public company balance sheets instead of residing in the footnotes (private companies will follow in 2020). This change in reporting does not fundamentally alter the overall health and credit quality of any company; but over the long-term, it will increase transparency around a company's financial obligations, and that could have a profound impact on how creditors view their potential for credit losses.
This is not so much an issue for large corporates rated by one of the major ratings agencies. Part of the rating process involves an in depth review of lease obligations. The agencies treat future lease obligations (adjusted for depreciation) as debt and rent payments as interest (this is something that TRA does as well when the data is available). But for the large population of unrated companies, it will allow us to more easily and accurately assess balance sheet strength. Landlords and asset managers will have greater awareness of their place in line should a tenant become distressed, and this standard more clearly reports a company's total financial obligations.
Let's Look at an Example
Leasing office space is fundamental to any player in the coworking space. Companies like WeWork enter into leases with landlords and then recruit members that act as defacto tenants. It is not hard to imagine WeWork maintains a large, global lease portfolio. When consolidated, the lease exposure is likely significant for WeWork. The pending changes in accounting standards will boil up the lease obligations and present them squarely on the balance sheet. As we stated earlier, this change in reporting does not signal a deterioration in WeWork's credit profile, but it does make it easier for landlords and creditors to see where they stand relative to other creditors, including other landlords. The substance of the lease obligations will still live down in the notes, but bringing leases on to the balance sheet will be an important improvement in financial statement quality and transparency.