Commercial Investment Real Estate July/August 2018 | Page 40

and categorization of all leases, as well as their terms and
options,” the paper states. “To ensure that all appropri-
ate information is collected, a coordinated effort must be
mounted internally, including accounting, finance, purchas-
ing, operations, and of course, real estate.”
The result, Conway says, is that “You’re going to have
a new committee-level process in these organizations that
didn’t exist before.” Conway, who is director of research
and corporate engagement at the University of Alabama’s
Center for Real Estate, says that in the past, “Gener-
ally, no one had to worry what John in the real estate
department did with a lease. It was a process of aligning
the economics with the construction costs and a certain
return on capital.”
New complications will overlay that fairly straightfor-
ward process. “Now the real question becomes the impact
on the balance sheet,” Conway says, “and you’ll likely see
a lot more friction between the CFO’s objective view of
the numbers and the very subjective nature of the lease
negotiation.”
Voluminous Upgrades
Needless to say, the new lease accounting “upgrades” are
voluminous. In 2016, Deloitte enumerated 12 essential
points governing the new standards. But they all boil down
to one essential question: What is considered balance sheet
and what is not?
“The new lease accounting will have an impact on record-
ing the liability of the lease,” Conway says. “I don’t think
it’s going to be sufficient to offset the full lease liability.”
Instead, he says, the CFO or the head of accounting will be
warning the real estate pros to avoid 20-year leases in favor
of five-year agreements with options to renew.
“The fact that the entire term of the lease obligation is
being booked as a contingent liability is going to radically
change some balance sheets for tenants,” says CCIM Insti-
tute Treasurer Les Callahan, CCIM. “You’ll have compa-
nies reporting current liabilities as opposed to long-term
liabilities, and that number is going to balloon — as much
as five or 10 times what was previously reported on their
balance sheet.”
Lending Institutions: Meet CECL
Welcome to FASB’s new guidance for current expected credit loss, or CECL.
“By the end of 2019,” says CCIM chief economist K.C. Conway, MAI, CRE, “every public financial institution
has to be able to forecast its loan loss reserves on real estate transactions on a loan-by-loan and forward-looking
basis.” That, he says, will entail a Herculean effort of transactional research that will dump directly at the doorstep
of every client of those loan institutions.
A sleeping giant of sorts, the new standards began shaping up when FASB started looking at how banks
calculated allowances for loan and lease losses (ALLL) after the 2008 financial crisis, according to ALLL.com.
“Under the new expected credit loss model,” the website explains, “financial institutions will be required to use
historical information, current conditions, and reasonable forecasts to estimate the expected loss over the life of
the loan. The transition to the CECL model will bring with it significantly greater data requirements and changes
to methodologies to accurately account for expected losses under the new parameters.”
In the past, Conway says, “Basically, banks and public financial institutions have forecast their CRE losses by
putting their finger in the air and averaging their annual losses and reserves accordingly, often with no data to
support it.”
But the SEC doesn’t want lenders to reserve too much. “They can do nefarious things with that,” Conway says.
“You can influence earnings with this extra pot of money.” But the Fed, on the other hand, wants lenders to hold
some capital back, essentially for rainy days. That push/pull is expected to be resolved through CECL by report-
ing losses and reserves “at a micro level, loan-by-loan and region-by-region.”
Just as with the new lease accounting standards, it is expected that the result of this depth of analysis on the
part of banks and their real estate clients will be greater transparency and reduced risk of another financial debacle.
That will come, however, after a year of redefining how real estate is accounted for, and any appreciation for
CECL will be realized post-2019. In the near term, as Conway jokes, somewhat sardonically, “CECL will be the
most unpopular guy at a real estate conference.”
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July | August 2018
COMMERCIAL INVESTMENT REAL ESTATE
by John Salustri