A new lease accounting standard, IFRS16, which brings future lease obligations on balance sheet, could accelerate changes to flexible working arrangements according to Pepper Property.
Pepper Property, the corporate real estate advisory division of the ASX-listed Pepper Group, which advises tenants throughout the leasing process, has seen significant changes in property usage over the years. Changes have ranged from individual offices, to open plan, to hot desking, with moves now towards shared and flexible work spaces. It is this latter trend which is likely to accelerate under the new lease accounting standard, which impacts both companies’ net profits, as well as their level of liabilities.
“The impact cannot be underestimated. Companies now have to consider the impact of a 10 year lease with the associated balance sheet and profit and loss impacts compared to the use of shared flexible spaces, which can create an appropriate work place environment, and which needn’t distort the occupancy expense, nor create a lease liability.” Andrew Foster, head of Capital Structuring at Pepper, said.
In recent years some corporate tenants have sought reduced lease lengths, and Pepper Property sees this trend, along with other lease structure changes, and re-consideration of space requirements, as being key considerations for any occupancy cost analysis. It is likely that some companies may want to re-think existing leases.
Notably, IBM recently signed a membership arrangement with the flexible work space provider WeWork for 600 employees in New York.
“All tenants, and landlords need to be fully across this, and it is very important that they consider the type of space required, as well as the lease structure,” said David Woolford, the recently appointed Head of Pepper Property’s Occupier Advisory division, “which is why we consider various forms of leases, and their resulting impact on balance sheets and the bottom line. It is no longer the case that the cheapest, longest dated lease will be the most effective.”
According to Pepper Property, a standard 10 year fixed escalating lease starting at $20m per year, could result in the lessee recognising a liability of nearly $200m. But equally importantly, the initial occupancy expense could increase by 10 to 15% as a result of the new accounting standard, with the expense reducing over the course of the lease.
The new lease accounting standard will almost certainly have an influence on decision making. “Financial reporting is something which boards and management take notice of. Acknowledgement of the lease commitments will inevitably see boards focus on the impact of long dated leases” Foster said.
“For example, historically, while the economic distinction between capital and operating leases can be minimal, companies always perceived operating leases, which had been off balance sheet, more favourably than on balance sheet finance leases”.
The new lease standard will be effective from 2019, although many companies will start reporting the impact ahead of that date.
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