What is Lease Accounting?

‍What is Lease Accounting?

Lease accounting refers to the process of recognizing, measuring, and reporting leases in financial statements. It is governed by accounting standards such as ASC 842 (U.S. GAAP), IFRS 16 (International Financial Reporting Standards), and GASB 87 (for government entities). These standards require organizations to classify leases as either finance leases (capitalized) or operating leases (expensed) and disclose lease obligations on their balance sheets.

For multifamily real estate, lease accounting primarily applies in two ways:

1. Lessee Accounting – When multifamily owners lease property or equipment.
2. Lessor Accounting – When property owners lease units to tenants.

How Lease Accounting Applies to Multifamily Real Estate

1. Lessee Accounting: When Multifamily Operators Lease Assets

Multifamily property owners and operators often lease assets such as:

• Land leases (if they don’t own the land but have a ground lease).
• Building leases (in cases of master leases or long-term property leases).
• Equipment leases (such as HVAC systems, appliances, or office equipment for property management).
• Corporate office space (if a management company rents an office for operations).

Under ASC 842, most of these leases must be recorded as liabilities and corresponding right-of-use (ROU) assets on the balance sheet. Short-term leases (less than 12 months) can be expensed without capitalization.

2. Lessor Accounting: Recognizing Tenant Leases

Multifamily property owners act as lessors when they lease units to tenants. Tenant leases in multifamily properties are typically operating leases (short-term, typically 6-24 months). Unlike lessee accounting, these leases are not capitalized on the balance sheet and are instead recognized as revenue over time.

Key Considerations

• Revenue Recognition (ASC 606): Rental income is recognized on a straight-line basis over the lease term, meaning discounts or concessions (such as "one month free") are averaged out.
• Lease Modifications: Changes in lease terms, such as rent abatements or extensions, may require re-evaluation under lease accounting rules.
• Variable Payments: Charges like utilities, parking, or pet fees may be considered variable lease payments and impact revenue recognition.

Why Lease Accounting Matters for Multifamily Operators

1. Financial Reporting Compliance – Publicly traded REITs, large property owners, and operators with significant lease obligations must comply with lease accounting standards.
2. Debt Covenant Compliance – Capitalizing leases affects financial ratios, potentially impacting loan covenants and borrowing capacity.
3. Expense Management – Understanding lease obligations helps multifamily operators optimize cash flow and budgeting.
4. Valuation & Tax Considerations – Lease liabilities and right-of-use assets can impact property valuations and tax reporting.

While tenant leases in multifamily properties are typically straightforward, lease accounting becomes more complex when dealing with corporate leases, land leases, and equipment financing.