Absent an unexpected about-face by the U.S. Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), the accounting rule applicable to real estate leases will dramatically change as early as 2012. The change, when implemented, will require that every real estate lease  (with some limited exceptions, such as mineral leases), whether in existence or entered into after the effective date of the new accounting rule, be treated as a capital lease for financial reporting purposes and therefore necessitate disclosure of the lease on the lessee's balance sheet. Under the joint FASB/IASB proposal, a "right-of-use" asset and a corresponding liability to make lease payments would be recognized for each real estate lease on the lessee's balance sheet, including best estimates by management of liabilities associated with term extension options and so-called contingent rents. The lessee would amortize the right-of-use asset over the expected lease term or the useful life of the underlying asset if shorter, and would incur interest expense on the liability to make lease payments.
The rule change will have significant financial statement implications to a company that leases real estate. Of most relevance to owners of commercial real estate properties, there is a high probability that the new rule would cause a lessee's financial statements to reflect lower working capital and a higher debt-to-equity ratio, and potentially reflect lower profits, all of which may significantly decrease the lessee's borrowing capacity. This should cause prospective commercial real estate users to significantly change the way in which they analyze and structure their real estate usage. Among the likely possibilities users will favor shorter term leases with more "contingent" rent or, in a marked change from historic norms, conclude that purchasing is more favorable than leasing. What can the savvy commercial real estate owner do to maximize its opportunities? For owners of multi-tenant properties that are willing to entertain the possibility of selling space as opposed to leasing it, and would like to have an alternative to difficult negotiations over lease term length and fixed vs. contingent rent, condominiumizing the property will expand the transaction structures the owner can offer to prospective users, and may therefore significantly enhance the owner's chances of both attracting a user and completing a transaction with that user. As evidence, the proposed lease accounting rule change was cited by Northrop Grumman Corp. as one of the important reasons supporting its recent decision to purchase, rather than lease, its new headquarters facility in northern Virginia.