There is a massive accounting change on the horizon that will have significant adverse implications on many commercial tenants and the way they view the tenure of their leased premises. It is something that has been overlooked by many if not most commercial tenants.
On 1 January 2019, the new IFRS 16 Leases standard will come into effect. This is an accounting standard introduced by the International Accounting Standards Board that will apply to those entities that prepare financial statements under the requirements of New Zealand equivalents to the International Financial Reporting Standards – such as (but not limited to) listed companies; building societies; ventures with international investors & stakeholders, and large privately-owned companies.
Put simply, the new standard changes the accounting treatment of lease payments from being an historical incurred expense under the profit & loss statement (statement of financial performance) to being recorded under the tenant’s balance sheet (statement of financial position) as a non-current liability for the present value of all future lease payments (including lease payments under all potential term renewals).
What is the reason for this accounting standard change? Apparently it is to provide for more transparency for investors and stakeholders. It will certainly help with that. However, it will have significant adverse impacts on many commercial tenants. In particular, it will result in higher debt levels on the tenant’s balance sheet, which may have significant adverse consequences for the tenant.
With significantly more debt showing on the balance sheet, a commercial tenant may have more difficulty raising finance or otherwise leveraging their business. Moreover, in the case of their existing financial accommodation, it may result in the commercial tenant being in breach of their bank covenants or other banking arrangements.
Shorter Lease Terms?
To keep balance sheet debt levels in check, commercial tenants will be forced to critically assess their short, medium & long term leasing requirements. Do they need a 6 year initial term with 2 rights to renew for further terms of 3 years each (ie. total potential term of 12 years)? This will significantly increase the debt showing on the tenant’s balance sheet and may hinder their ability to leverage the business and take advantage of opportunities in the future. Can the tenant instead get by with only an initial term of 3 years with a right to renew for a further term of 3 years (ie. total potential term of only 6 years)?
Where a commercial tenant is prepared to take a shorter lease term, can they even negotiate that. Shorter lease terms are not that easy to get. Landlords generally want to lock tenants in for as long as possible, as this increases the value of their property.
In addition, where a Landlord is being asked to make improvements to the premises at its cost, it will generally only do that if it is able to recover that cost by way of increased rental payments over the tenant’s committed term. A shorter initial term is generally not conducive to such an arrangement.
What should you do?
We recommend that you check with your accountant to find out if the new IFRS 16 Leases accounting standard applies to you.
If it does and you are considering leasing premises sometime in the future (whether new premises or negotiating a new lease of existing premises), then we recommend that you start considering your future lease tenure and leveraging requirements, and the consequential implications of the new IFRS 16 Leases accounting standard on the future bankability of your business.
As commercial leasing specialists, we can help you negotiate the most advantageous leasing arrangements bearing in mind the above considerations. Give us a call today on 04 970 3600 or email us at firstname.lastname@example.org