As globalization becomes more and more of a reality in modern life, the ramifications reach far and wide.  One such march toward global unity through adopting International Accounting Standards Board (IASB) practices may have dire implications on retail real estate. 

The United States is the largest economy that does not currently adhere to the standards set forth by the IASB.  However, as soon as December 2011, that may change.  There is a convergence plan being contemplated by the U.S. Security Exchange Commission, and in the very near future, the Generally Accepted Accounting Practices (GAAP) for public and private companies could be in accordance with the IASB.

The largest concern for industries such as construction and real estate is how leases are accounted for by IASB standards.  Currently in the United States, leases are generally recorded as operating expenses in the present year only.  Future details of the lease obligation are disclosed as footnotes, but the risk / financing are off-balance sheet.  The IASB treats virtually all leases (including equipment leases) as capital expenses, and the asset and liability are recorded in full at the inception of the lease.  Further, the IASB liability calculation includes the likelihood that a tenant would exercise option(s) to renew.  Options to renew could now be deemed a detriment to a tenant.  Consider what a new balance sheet will look like when a large regional or national tenant has to book the gross value of all their existing leases, plus all options to renew that are likely to be exercised, as a liability.  

I recently had the opportunity to hear Keith Eldredge of ParenteBeard, a CPA and Business Advisory Firm, speak on the proposed IASB changes and the potential fallout.  First and foremost, the new accounting standards will immediately place many companies in violation of their loan covenants.  Ratios will skew, and Keith speculated the already battered banking industry could run for cover and start calling loans.  At the very least, loans will need to be modified and banking relationships will be affected.  Also, lease provisions such as amortization of tenant fit-outs, percentage rent, and escalation clauses will have new ramifications.  Finally, tenants seeking to keep the liabilities off their balance sheets may opt to commit to shorter term leases.  The way to keep a lease as an operating expense is to only commit to one year at a time, with no renewals.  That undermines the fundamental value of commercial real estate investments, as the security of cash flow becomes greatly compromised.

There are a number of different opinions on the chances the IASB rules will be adopted and to what extent.  Some say it is a sure thing.  Others say it will only apply to the public sector.  Others believe it will be squashed altogether.  Given the potential consequences, it certainly is worth paying attention to the course it takes.