Straight Line Rent Adjustments
- 01:20
Understanding the accounting behind straight-line leases
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Straight line rent adjustments. Straight line rent adjustments are a peculiarity that requires some explaining, as they're mostly a creation of the accounting authorities. Here is an example where we have a base rent of a 100 and a 3.5% contractual increase each year for the next four years. Total lease payments for the life of the lease are 536.3. Now, if we divide that by the lease term of five years, we get an annualized amount of 107.3. This is the amount that would be recognized in the financial statements. Economically speaking, there is a 7.3 overstatement of red income here in year one that does not match the cash flow generated, which was 100. AFFO would back this out of the equation so that the economic reality is what is being considered. Note well that the gap between the accounting and the economics reverses over time, and the sum of the overstated and understated amounts will actually total to zero by the end of the lease term. Where this would have a big impact on the numbers is in the case of a building, for example, that has many early term leases or one that has many late term leases.