Office tenants should prepare for the upcoming changes
IFRS 16 - the new lease accounting standards - will come into force on 1st January 2019. According to the JLL report, “IFRS 16: What will the future bring?”, the new regulations will result in changes, especially in the case of property tenants - and office tenants in particular. How will the real estate market respond? According to JLL, it will be possible for companies to put pressure on reducing the length of lease periods, limiting the number of “sale and lease back” transactions as well as bolstering the development of flexible office and co-working spaces. In the long-term, the overall impact of the new accounting regulations on take-up volumes should be limited.
IFRS 16 was concluded by the International Accounting Standards Board (IASB) in January 2016 and is applicable for accounting periods beginning on or after 1st January 2019 (early application is permitted in the case of entities which introduce IFRS 15 upon revenue recognition).
“From the perspective of property owners, the changes made by the IFRS 16 are not significant and, apart from sublease arrangements, lessors will not be subject to major adjustments on the transition date. Significant changes have, however, been introduced for the lessee recognition model – for instance regarding office tenants. Therefore, it is expected to have a noticeable impact, particularly for entities which keep a large proportion of their financing as ‘off-balance sheet’ items in the form of operating leases”, explains Tomasz Król, Senior Manager, IPS Business Solutions, JLL.
What does this mean? The operating lease accounting model will no longer be available, except for short-term leases (with a non-cancellable lease term of up to 12 months), and agreements covering low-value assets (while the threshold has not been explicitly defined, the IASB interpretations indicate an amount of USD 5,000). All other lease contracts must be recognized on the balance sheet in a similar way as that which is currently applicable to contracts meeting the criteria for finance leases.
“The new reporting process will involve entire businesses, including operations, accounting and finance, along with the real estate, IT, legal and tax departments. As a result, the critical first step towards planning the new reporting process is to involve all of the parts of a business while identifying potential areas of impact”, adds Tomasz Król.
IFRS 16 and the real estate market
As the JLL report highlights, due to the fact that the new accounting regulations indicate a necessity to transfer lease obligations to a company’s balance sheet, pressure to shorten the terms of leases may be felt.
In Poland, rental agreements are currently on average concluded for a five-year period. Hence, the so-called break options, e.g. the option to terminate the contract after three years, may become more popular. On the other hand, the new IFRS16 accounting standards may have a positive impact on older office buildings, as landlords of these are more willing to offer shorter rental periods than the owners of recently completed or planned office developments. A three-year lease concluded for an older asset will have a smaller financial impact on a company’s balance sheet.
Sale and lease-back transactions will, in JLL’s opinion, also be affected by the new changes introduced by IFRS16 arrangements where the seller of an asset leasing back the same asset from the purchaser will become even more rare. One should note that such solutions have never been popular on the Polish real estate market, and new lease accounting rules may result in even further limitation of sale and lease-back deals.
On the other hand, the new IFRS16 may result in the opposite situation to the one described above, as companies might look to acquire their own property or to build space for their own use rather than leasing it. However, one should take into account that the process of securing a plot and constructing an office building is rather complicated, time-consuming, and requires specialist knowledge. An important issue arising from such a solution is also connected with the difficulties in adjusting the size of a building to the actual needs of a company.
A possible solution that will certainly emerge in the real estate market is the development of entities that will lease substantial parts of office buildings (entire floors or several floors) or even entire properties, for example, for 10 years and then rent out that space for shorter periods of time. There are some companies that are planning to conduct such activities.
The new IFRS16 accounting standards may even result in the faster development of flexible and co-working office spaces. The main advantage of the providers of such office spaces is that they can offer short and flexible leasing agreements, or membership. According to the new standard, leases below 12 months will not have to be included in a company’s balance sheet.
The new accounting standard will gradually change the Polish office market. However, one must remember that demand for office space in our country is constantly growing, particularly in cities outside of Warsaw. As a consequence, the overall impact of the new accounting regulations on take-up volumes should be limited, as the majority of companies here will continue to rent offices and not start their own developments. The main change will be to the flexibility of lease agreements, to which the market will slowly adjust.
 International Financial Reporting Standard 16