Eight years since it was first floated, the International Accounting Standards Board (IASB), along with U.S.-based Financial Accounting Standards Board (FASB), have announced that all leases must be recognised as lease assets and liabilities on the balance sheet by the end of 2019.
While the new rules will affect all leases, real estate represents the lion’s share and is a major expense for many large companies. This change is particularly significant for financial institutions, retailers, health-care companies and others that rely heavily on leased facilities for their operations.
First proposed in 2007, the standard has been in the pipeline long enough for many organisations to forget about its implications and has become something of an industry hot potato, subject to seemingly endless debate.
Rent Vs. Buy
“For anyone involved in the business of buying, selling or leasing real estate, this change signals a new world of asset management and will force strategic reviews of portfolios across the board with almost every occupier asking: should I own or should I rent?” says Michael Evans, Director in JLL’s Corporate Capital Markets team.
So what does this mean in practice? For investors and occupiers, the implications are potentially huge and even with three years before the rules come into force, collecting the data required to calculate the impact chalks up to a significant administrative burden.
The investor impact
The most forward thinking investors may change their approach to try and capitalise on the changes and create leasing deals that are more appealing under the new standard, says Evans.
“We may potentially see a growth in serviced offices and co-working – not only does it create greater flexibility but its initial balance sheet impact is limited. We could also see an end to rents with fixed uplifts – they represent the worst of all worlds under the new standard – and the development of a suite of sale and leaseback offers could materialise, including strip income, ground rent and turnover rent products.”
The occupier impact
For occupiers, the changes could bring about a move towards property ownership given that they will put an end to the off balance sheet benefit of leasing.
For some companies, shorter term leases are expected to become more attractive by means of reducing the balance sheet and profit impact on a company’s financial statement.
For retailers, turnover rents are likely to prove popular: “To the extent the rent is uncertain then it will not need to be recognised on balance sheet. So rents that are a percentage of turnover could be very attractive to retailers,” adds Evans.
The U.S impact
While the U.S. is governed by the FASB, a different accounting body to the UK, the changes translate across the Atlantic with the implications for investors and occupiers mirroring those above.
Michael Billing, Managing Director, Consulting, in JLL’s Integrated Portfolio Services business said, “The FASB and the IASB have concluded that investors, lenders and other users of financial statements need a more accurate picture of the long-term financial obligations of the companies in which they invest. It’s basically a continuation of the U.S. Sarbanes-Oxley Act of 2002, and it’s all about providing transparency to the users of financial statements.”
However, he points out that accounting rules are only one factor in the lease-or-own decision. Economics, portfolio flexibility and operational requirements should still be the primary drivers.
In the meantime, JLL advises most companies to begin to take action by analysing the impact of their leased property portfolio on their financial statements; evaluating alternative strategies to reshape their portfolio and identifying how they are going to collect the information and prepare for implementation.
“Given long-established funding and investment structures we are unlikely to see changes overnight,” added Evans. “Many companies may take the view that their cash position doesn’t change. Private companies, for example, who do not have the pressure of shareholders or analysts to contend with, may be indifferent to the changes.”
Head of Corporate Capital Markets, JLL EMEA