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A change in lease accounting: tenants will want shorter leases

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If you’re in commercial property as a tenant or a landlord (or if you lease equipment), then you should by now have heard of the IFRS16. Stay with me - what was previously your operational lease has now been overridden and there’s some stuff you need to know! Thanks to a ruling in 2016 by the International Accounting Standards Board (IASB), the IFRS16 means you now have to recognise your lease on your annual balance sheet: as an asset if you are a landlord and as a liability if you are a tenant. This is a change to global accounting standards and there’s plenty of time to unpack and implement this, as the changes don’t come into effect until 1st January 2019 (so would be included on reporting lodged on or after this date).   

Of course, anything that requires you to do more accounting could be seen as bad news but in this instance, it just means those in commercial property – especially landlords – need to think more creatively about how they manage their properties. The immediate impact is that longer term leases, which are traditionally more appealing to landlords, are now less appealing to tenants, who previously may have liked the security that came with the deal. Seeing the dramatic changes to their balance sheets post January 2019 however, will no doubt have them quickly changing their tune. The tenant’s priority now will be to spread the liability that comes with their long-term lease, over more than one reporting period (to minimise the impact on the balance sheet of the first reporting year of their tenancy); or to just not sign on to long term leases anymore. 

As a landlord, it has always been preferable to secure longer term leases, which not only secure income on the property for a decent chunk of time, but also improve the value of their property. However, if you are now declaring the value of that lease as an asset in one accounting period, it also benefits landlords to spread the numbers a little too. The time periods need not change necessarily, but the lease periods may need to. For example, signing a lease with options that covers an 8-year period, but actually is a 2-year lease with two extension options of 3 years each. This means there is still an 8-year agreement of sorts in place, but the asset/liability for both the tenant and the landlord is spread (at a reduced value) across three accounting periods.

This means landlords can still aim for the security and capital value of a longer-term tenant, in principle, and offers some advantages for tenants too. Landlords who decide they want a long-term lease and show no flexibility, will find tenants much less willing to work with them once the new reporting standards have been established. Situations where this flexibility is particularly useful might be where a tenant wants the short-term lease option on paper, but in reality, wants to invest in an expensive interior fit out, say for a café or a retail store. Spending a small fortune to set their business up is pointless for a 2 year lease, but knowing that their fit out investment has options to extend could be the deciding factor. Especially if it’s a brand new business who wants a good 5 years in one place to get established.

As always, the best way forward is to get professional advice from your real estate agent, accountant or financial advisor (or all three!). The legislation will not come into play until next year but your next lease renewal could be anytime before that so get some good advice and get in early, or you may well lose out in the long run.

 Commercial Property Investment Guide

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DISCLAIMER

The following advice is of a general nature only and intended as a broad guide. The advice should not be regarded as legal, financial or real estate advice. You should make your own inquiries and obtain independent professional advice tailored to your specific circumstances before making any legal, financial or real estate decisions. Click here for full Terms of Use.

 

Tags: Renting, Investing

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