The commercial real estate finance sector has been cautious in regards to worsening conditions in the global economy and a slowdown in the U.S. economy. Although investors feel that the market is holding, tightening lending and accounting regulations are putting more pressure on commercial real estate players.
Increased Regulation Signals Higher Costs for Borrowers
Since the recession, stricter lending requirements have come into place and are impacting the commercial real estate industry. Due to the Basel III regulation regarding high volatility commercial real estate (HVCRE) that took effect in early 2015, banks with over $500 million in assets, including savings and loans institutions, must allocate increased capital for certain construction and development loans.
This increased regulation placed on the lenders directly affects commercial real estate investors by translating into higher rates, more complex documentation requirements, and tighter terms. Instead of underwriting to pro forma with projected rent growth, many banks are now underwriting to current rental rates and reducing the loan-to-value (LTV) ratio to less than 70 percent, which is more conservative than the historical norm of 75 to 80 percent.
With many banks picking and choosing those with whom they’ll do business with, there has been an uprising of unregulated lenders – such as pension and private equity funds and life insurance companies – who are willing to lend, albeit often at a higher rate. This is a good option for those borrowers who require a speedy transaction.
New Accounting Guidance Affects Commercial Leases
In addition to the tightening lending environment, changes are also coming for commercial leases. In February of this year, the Financial Accounting Board (FASB) issued its Accounting Standard Update that becomes effective for public entities on December 15, 2018, and for non-public entities on December 15, 2019. The main provision calls for all lease transactions with terms in excess of 12 months to be recorded on the balance sheet of the lessee (tenant). The Standard also acts to consolidate all of the various lease guidance that currently exists in the Accounting Standards Codification (ASC) 840, Leases, which includes accounting for sale-leaseback transactions and guidance on determining expected lease payments and lease terms.
The new standard has a relatively small impact on lessors (landlords) but will have a significant impact on any entity that engages in leasing activities due to the required detailed data for financial reporting and new disclosure requirements. For those entities that rely heavily on leasing for a major source of income it’s possible that classifications in the statement of cash flows may differ, while cash flows will remain the same.
Meissner Jacquét is a full service commercial real estate firm offering institutional-level financial and accounting services. Our accounting team is expert in commercial accounting methods and real estate transactions. Meissner Jacquét delivers client-focused, scalable and innovative solutions, allowing our clients to leverage our resources.
To ensure you’re prepared for the coming changes in the commercial real estate finance sector, contact Brent Williams or Allison MacDonald to learn how our fully-compliant accounting software delivers the most advanced and accurate financial reports.
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| Brent Williams [email protected] 858.373.1113 |
Allison MacDonald [email protected] 858.373.1354 |
Sources:
NAIOP Development, Summer 2016, Volume XLVII, No. 2, CRE Lending Environment Tightening
NAIOP Development, Summer 2016, Volume XLVII, No. 2, Accounting Changes Coming for Leases
Meissner Jacquét Commercial Real Estate Services