As the end of 2019 approaches, there will be a few things in commercial real estate leases that will change in 2020 that you need to know about.
Short-term Lease
Lease accounting standards will be changing for private companies. Lease costs will be accounted for differently, which means short-term leases will be more popular than ever.
Currently, long-term leases (longer than 12 months), have a large amount of bookkeeping that is required with ASC 842. The shorter-term leases will affect their balance sheets, but in different ways.
Short-term commercial real estate leases are becoming more popular. Tenants appreciate these leases due to the benefits such as:
- Flexible space
- Co-working
- Pop-ups
- Shared space
- Changing demands
Tenants will experience more flexibility, which gives landlords less certainty with budgeting and planning and their tenant mix.
If the landlord is using a discounted cash flow model, the short-term lease could cause him/her to change to a valuation model. There are a few factors that carry weight in the valuation model:
- Higher expenses
- Shorter leases
- Lease commissions
- Marketing costs
- Change in vacancy rate
- Rental premiums to offset expenses
- Replacement building costs
Tenants may consider entering a short-term lease and reassessing annually. Reassessing can save him/her money if there’s a better economic leasing option available.
Landlords may provide incentives to tenants in order to agree on a long-term lease. This guarantees a fixed rental income for the Landlord each month for a longer period of time, as opposed to the short-term lease.
Short-term leases affect the tenant, landlord, and both parties in their capacity as a borrower. This shorter commercial real estate lease may affect a borrower’s access to credit. Initial direct costs and disclosures will be required on the balance sheet, instead of as a footnote. All lease types cover the possibility that the borrower may default. The good news is, for the most part, the rate of defaults has stayed low.
Recourse Loans
The borrower is personally liable for the loan due if using a recourse loan. Recourse loans “can help a lender recoup its investment if a borrower fails to pay the liability and the value of the underlying asset is not enough to cover it. A recourse loan lets the lender go after other assets of that debtor that were not used as loan collateral.”
For example, if a tenant stops paying rent, files bankruptcy and is eventually evicted, the landlord may have a lien on the tenant’s equipment. This may allow the landlord to sell the equipment in order to recoup the unpaid rent- of course, it depends on what the lease says, it will ultimately control. With recourse loans, the landlord cannot exercise that lien.
Recourse loans and landlord liens greatly reduce bankruptcy filings. Borrowers often use bankruptcy to avoid receivership and stop foreclosures. This is a pain to lenders and can take years to resolve.
Non-recourse Carveout Guarantees
With short-term leases, there are also non-recourse carveout guarantees. This means that the guarantor is either partially or not liable for repayment of the principal and interest on the loan. It’s important to have a commercial real estate attorney that will negotiate the wording in this area. Non-recourse carveout guarantees are imperative. It ranks right up there with rate, proceeds and terms.
Texas has a quick, non-judicial process when dealing with foreclosures.
Learn more about how a short-term lease can benefit you by filling out the contact form at the bottom of the page today!
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