When Airbnb dramatically changed the model for travel rental properties, it sparked a growing desire for flexible rental and leasing arrangements throughout the real estate industry. Short-term rental arrangements are on the rise, with hotels, retail and commercial office landlords offering their versions of short-term leases. For example, the high rate of retail store closures is driving retailers to request flexibility in their lease arrangements with landlords. After all, no one wants to default on a lengthy lease. So what does this mean for the overall real estate economy?
Millennials Setting the Pace
More millennials are becoming entrepreneurs, and they want the flexibility that short-term office leases offer. Even large corporations are starting to follow their lead by offering employees the ability to set up shop in any number of their locations throughout the U.S. and even worldwide.
As we addressed in an earlier blog, the growing demand for co-working spaces commercial is transforming the real estate market. Millennials – expected to make up half of the workforce by 2020 – are behind the great surge in co-working spaces. In seeking flexible work arrangements, the idea of the traditional commercial office building environment is not as appealing as it once was. Rather than signing a traditional 10-year commitment, tenants in co-working environments want flexible, short-term leases.
Bending the Long-Term Leasing Mindset
Can the short-term leasing model fit into the long-term property model? First, we should consider the new lease accounting standard (ASC 842) that already went into effect for publicly traded companies in 2019 and will become effective for all companies in 2020. Part of the intent behind the standard was to align with the Federal Accounting Standard Board’s (FASB) new revenue recognition standard. However, for leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election not to recognize lease assets and lease liabilities. This only adds an incentive for tenants to demand flexible leases as companies will be required to record lease obligations on their balance sheets.
There will also be tax issues to determine. For example, how should the government tax properties that are sometimes residential, sometimes commercial or both at the same time?
Not surprisingly, many investors are wholeheartedly embracing the short-term rental sector. For example, Brookfield Property Partners invested $200 million in an Airbnb joint venture with the real estate developer Niido for developments in which tenants can rent their units for up to 180 days a year.
From a financial perspective, the flexible leasing model makes sense for commercial leasing. As businesses grow and contract, companies must often pay for space they are not using or – at the other end – they need to fit people into insufficient spaces. The short-term lease model might better accommodate a business’ needs and allow it to run more efficiently.
As flexible, co-working spaces increasingly become a viable alternative to the traditional office space, we can expect more tenants to either restructure their leases or sign new leases with shorter terms. This trend leaves landlords a bit unsettled because lenders may not be as likely to provide long-term financing on shorter commercial property leases. Banks, which traditionally like long leases with good tenants, are still trying to understand the reporting requirements associated with the new lease accounting standards. Still, there is a healthy appetite for lenders to provide loans to tenants in this new short-term lease environment. It will be a learning curve for lenders and lessees alike.
Questions about the new lease accounting standards or other real estate issues? Contact Eric Olsen, CPA at (972) 818-5300 or fill in the form below.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.