You are here

New lease standards add burden to tenants, landlords

Thursday, April 7, 2016 - 05:50

AFTER nearly five years of deliberation, the International Accounting Standards Board (IASB) issued the revised leasing standard IFRS 16 in January 2016. IFRS 16 will replace the current IAS 17 for companies with annual reporting periods beginning on or after Jan 1, 2019. Before the new standard becomes effective, tenants, landlords and stakeholders should take the time to understand the implications that the new standard might have on them and for Singapore's real estate industry.

TENANT'S PERSPECTIVE

Currently under IAS 17, property lease contracts are classified as either operating leases (where they are not part of assets and liabilities - commonly referred to as "off balance sheet") or finance leases (where they are included in assets and liabilities - commonly referred to as "on balance sheet"), with the majority classified under the former.

When IFRS 16 comes into effect, almost all leases will have to be recognised as "right of use" assets with corresponding lease liabilities. This will have an impact on the tenant's key financial metrics, including increased leverage ratios and potentially lower return on assets.

sentifi.com

Market voices on:

In addition, tenants will need to split the lease and non-lease (such as service charge) components in the contract and recognise only the lease components on the balance sheet. In a recent PwC study on the impact of the new lease standard on tenants across all industries and sectors, it was found that 53 per cent of entities surveyed will see an increase in their debt of over 25 per cent.

Zooming into the retail sector, the survey found that the median increase in debt for retail companies is 98 per cent, effectively almost doubling their debt. In addition, the new standard's additional requirements on disclosures, contract and data management may incur significant costs for tenants - in terms of finances and other resources. Retailers in Singapore are already facing pressures on their operating models, and this clearly is something retailers need to prepare for.

LANDLORD'S PERSPECTIVE

For landlords, comprising mainly property developers holding investment property portfolios, Real Estate Investment Trusts (Reits) and private real estate funds, the accounting treatment for leases remains largely unchanged from the current IAS 17 in which the underlying properties will continue to be reflected as an "investment property" for operating leases or "lease receivable" for finance lease on the balance sheets. Similar to tenants, the vast majority of leases are classified as operating leases.

Prima facie, it may appear that IFRS 16 will impact tenants but not landlords. However, landlords should also consider potential wider commercial implications.

Firstly, as only unavoidable lease payments will be recognised on balance sheets, tenants may be incentivised to negotiate for shorter lease terms with option for renewal or incorporate higher variable elements such as turnover rent for the retail industry in the rental agreements in order to lower the amount of leases recognised on their balance sheet. This may in turn adversely impact the key performance indicators (KPIs) for many landlords, including shorter weight average lease expiries, uncertainty in asset yield and volatility in cash flow. Landlords will therefore need to find the right balance between managing uncertainty and retaining tenants in this competitive environment.

Secondly, many tenants, particularly those in the small and medium enterprise segment, may lack the necessary expertise or processes to appropriately record leases under IFRS 16. These tenants may therefore request that their landlords provide the necessary support services, including furnishing detailed analysis of financial impact from the lease agreement both at the start and during the lease term and estimating service fees (non-lease) components in a lease contract. Such support services may become part of the landlord's responsibility, leading to higher operating costs (personnel, systems etc) which may not necessarily be recoverable in the light of the current competitive leasing environment.

Thirdly, some landlords in the industrial or logistics space are currently required to make annual rental payments to JTC Corporation and these lease arrangements are classified as operating leases under IAS 17. As this group of landlords is essentially lessees themselves in relation to JTC as the landlord, the rental payments will need to be recognised on balance sheet under IFRS 16. In addition, there will be complexities in the valuation of the underlying properties which are reflected in these landlords' balance sheet as investment properties (for example, distinguishing "right of use" asset from the current traditional investment properties).

Lastly, another affected group may be the sponsors of Singapore-listed hospitality trusts. Under the current regime, sponsors of hospitality trusts often take on the role of master lessee, allowing for the trusts to earn passive rental income. These master lease arrangements with terms normally exceeding 10 years are currently treated as off-balance sheet operating leases. Again, this will need to change under IFRS 16 with such leases being recognised on the balance sheet.

PLANNING AHEAD

While there is still more than two years before IFRS 16 becomes effective, both lessors and lessees should start to consider both the accounting and commercial implications of IFRS 16 on their businesses as this is going to have a pervasive impact across accounting, regulatory environment, KPIs, IT systems, business processes and controls. Lessees and lessors should plan ahead and create a road map to effectively address the challenges that IFRS 16 will bring. They can do so by taking actions such as performing gap analyses between IAS 17 and IFRS 16 to identify issues and affected areas, developing automated tools and templates to collate data and quantify impacts, establishing policies, defining business processes and technical requirements, and communicating with and managing stakeholders.

  • Yeow Chee Keong is real estate industry leader; and Chen Voon Hoe is accounting advisory leader at PwC Singapore
Nespresso
Pair your daily business read with the perfect cup of espresso.

Subscribe to The Business Times today to receive your very own Nespresso Inissia coffee machine worth $188.

Find out more at btsub.sg/btdeal

Powered by GET.comGetCom