IFRS 16: Potential Changes in Real Estate Strategies

Wed 22 May 2019

The standard IFRS 16 on leases is applicable to financial periods current at 1 January 2019. It applies to listed companies, their consolidated subsidiaries and entities presenting their accounts under international financial reporting standards (IFRS).

The standard seeks to improve the presentation of leases in the accounts, and requires lessees (tenants) to account for leases directly on the balance sheet. In the income statement, rental payments are replaced by an amortisation expense and an interest expense.

The International Accounting Standards Board (IASB) has estimated the value of off-balance sheet leases in the financial statements of listed companies at 2.86 trillion USD^[1]. The travel and leisure industry is the real estate segment most affected, with 20.7% of the total balance sheet impact^[2].

Impacts on indicators of performance and profitability in the financial statements

The standard will have new impacts on the key performance indicators of lessee companies:

• a fall in net debt and an increase in interest expense;
• worsening liquidity ratios (due to increased lease liabilities) and asset turnover (due to the increase in assets);
• improved Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) and operating result;
• an increase in operating cash flows and a reduction in financial cashflows.

Regulatory and prudential capital ratios for the subsidiaries of financial and banking institutions are also affected. More generally, banking covenants backed by financial statements are subject to renegotiation.

IFRS 16 entails organisational changes and could have a significant influence on the business and real estate strategies of lessees. The challenge lies in modelling the different alternative scenarios in order to find the optimal solution.

Expected changes in lease accounting practices

The lease term has considerable impact on the measurement of the debt; consequently, stakeholders may try to reduce it, in particular by agreeing extension options. In the future, this approach could work against today’s widespread trend towards entering into long leases in return for rent holidays or reduced rental payments.

Secondly, fixed lease payments may in future be preferred over variable lease components, since some aspects of variable lease payments are not included in the changing value of the lease liability.

The implicit lease rate (the rate that the lessor invoices to the lessee) may also influence lease practices and the hitherto generalised methods of financing assets.

^[1] Source: Effects Analysis | IFRS 16 | January 2016

^[2] Source: Effects Analysis | IFRS 16 | January 2016