New reporting rule makes leases debt

Anyone leasing office space, retail premises or industrial property needs to get to grips with a $4.5 billion liability that could affect their business.

That’s the advice from commercial real estate giants CBRE who say that, while IFRS 16 may not have the most exciting name, it is a new international accounting standard demanding attention from many New Zealand businesses.

Six years in the making, IFRS 16 will require leases to be carried on corporate balance sheets from January 2019.

It is a material change in the way corporate occupiers will account for lease obligations.

CBRE senior managing director Brent McGregor said the new standard was likely to bring significantly greater rigour around leasing decisions and reporting practices, as most leases would move onto balance sheets as debt – in financial reporting terms.

‘‘The current rent roll for commercial property in New Zealand’s main centres totals approximately $4.5b.

‘‘Like it or not, for corporates required to report under IFRS, from 2019 a large part of this rent roll will be recorded on the liability side of corporate balance sheets.’’

That will generate debate around several issues, including the market’s likely response, the potential for a swing towards property ownership over leasing, and questions around optimal types of lease review and renewal provisions, he said.

Physical need for leased accommodation wasn’t likely to change significantly, he said.

But under the new regulations, banks and analysts would exert stronger influence on property leasing decisions, McGregor said.

Historically, long lease transactions in New Zealand had attracted tenant incentives which could substantially cover fit-out and other costs, he said.

With the pending rule change, there was speculation around what would become the ‘new normal’ in terms of lease length and the standard’s influence on future incentives, he said.

Up until now, unless a particularly long lease was being contemplated, financial reporting considerations were not a driving factor in leasing decisions.

‘‘How the rule change plays out in the property market will depend in large part on how banks classify rental liability in terms of corporate debt covenant ratios and in respect of listed companies. We expect analysts and bankers to ‘look through’ to the substance of the relevant transactions but it would be prudent for occupiers to engage with stakeholders early.’’

Corporate occupiers should, if necessary, renegotiate debt covenants earlier rather than later to protect value, McGregor said.

However, there was ‘‘no need to panic’’ as the property market had three years to come to grips with the rule change – which had little impact on actual net cash flow in practical terms.

CBRE structured transactions and advisory services director John Holmes said IFRS had the potential to change tenant behaviour because of its impact on balance sheets.

‘‘Balance sheets are a snapshot of a company’s financial state. When IFRS 16 comes in and lease costs are counted as a liability on the balance sheet, occupiers may seek shorter lease terms so that the balance sheet liability is lower than what a longer lease would entail.’’

For a building occupier, longer lease terms are generally more attractive, so if tenants drive some shift to shorter lease terms , those building with existing long term leases in place will become more attractive from an investment perspective, he said.