CyberLease’s analysis of the recent FASB and IASB Exposure Drafts on new lease accounting rules reveals that after the rules are implemented tenants will actually reduce their near term profits by executing the popular “blend and extend” lease restructure.  For tenants and their advisors this means any contemplated “blend and extend” negotiations should be undertaken and completed as soon as possible in order to realize the fullest benefits possible before the lease accounting rules change.

Currently, the “blend and extend” concept is pursued on the basis it provides three key benefits to a tenant, namely it (1) conserves cash flow, (2) takes advantage of a down market to lock in lower rates for the future, and (3) improves current and near term profitability as compared to the existing rent structure.  Under the current accounting rules (i.e., FAS 13), all three benefits can be achieved.  However, after the newly proposed lease accounting standards are implemented, virtually every conceivable “blend and extend” deal will reduce current and near term profitability.  This is because the new lease accounting rules will require leases to be capitalized on the tenant’s financial statements, with front-loaded interest and depreciation expense hitting the tenant’s income statement rather than a straight-lined rent expense under current FAS 13 rules.

Since the new lease accounting standards will eliminate the near term profit improvement that would otherwise have occurred under FAS 13 from a “blend and extend”, going forward the benefits from improved cash flow and locked in future rental rates will need to outweigh the near term profit impairments.   As this chart below demonstrates, the GAAP-based profit impairments are material and hard to overcome. 

As a result, CyberLease believes the “blend and extend” is on the equivalent of its farewell tour; imagine the case of the CRE director or CFO executing a “blend and extend” – or their broker advising them to do so – after the new rules apply without considering the adverse impact on profitability.  However, a unique window of opportunity exists for tenants to take full advantage of blend and extend deals while FAS 13 is still in effect and – as an added benefit – reduce the balance sheet impact of that lease once the new lease accounting standards go into effect.   Click here to learn more about the proposed standards and how we can help you navigate the new waters of lease accounting.

View Full Sized Graph