If a fast-growing, growth-stage startup, desperate to find great office space, signs a 7-year lease at an average of $1 million per year in rent, nothing changes to the long-term liabilities in their financials. Now, the company is on the hook for a million dollars per year. What if they downsize? What if they need more space? It seems strange that the same company, whether they have seven years left on an office lease or one year left, doesn’t reflect that huge liability somewhere, encouraging companies to sign longer leases since they’ll get lower rates and more tenant improvement allowance at the beginning, and thus making the company look better in the short-term.
Well, the Financial Standards Accounting Board is five years into a project to change the standards around accounting for leases. While it isn’t finalized yet, the net effect is that companies are going to have to recognize assets and liabilities that come from lease transactions.
Here are a few ideas on how more transparent recognizing of leases will affect the market:
- Lease terms will be shorter on average
- Companies that can commit to longer terms, and the corresponding liability, will be given more concessions by landlords
- Furnished, short-term office environments, like the Atlanta Tech Village, will see increased demand
- Subleases will be more aggressively reviewed (and the flip side is that companies will look to get out of their liabilities more aggressively by subleasing space)
The amount of liabilities out there for companies with long, expensive commercial real estate leases is staggering. While a FASB change won’t cause the market to correct overnight, it will have a fundamental change on commercial real estate leases.
What else? What are some more thoughts on accounting rule changes that will drive more companies to look at shorter-term leases?