By ERES President Tom Bradley
Beginning on January 1, 2019 the new lease accounting standard IFRS 16 went into effect which essentially requires tenants/lessees to now report lease liabilities on their balance sheets. This new requirement eliminates nearly all off balance sheet accounting and has a far-reaching impact on lessees’ business processes.
Who is Affected
IFRS 16 is an international tax law that mostly impacts companies headquartered in Europe. However, there are impacts well beyond this core base of companies. ERES recommends working with your corporate internal finance department to better understand how it might impact your firm.
For those companies affected, this new accounting standard could have major impacts on your real estate strategy. Here are a few things to consider:
Driving for a Shorter-Term Lease
One obvious strategy is to always drive for a shorter-term lease. Shorter term equals less liability on your balance sheet. Keep in mind, short term leases aren’t always the most practical solution especially in the rural energy markets. Why?
- Supply is generally limited and locking in a longer term at a static rate can save big dollars.
- The cost of improvements from unique build outs, and constantly moving to different facilities creates business interruptions, is inefficient, and simply might not make sense for your business operating strategy. In addition, rural market construction costs are generally very high.
Impact on Lessor
With IFRS 16 now active, it’s more important than ever for landlords to know their tenants. By learning which tenants in your portfolio are impacted by the new standard, owners will understand those tenant’s newly defined priorities and can better plan for lease negotiations or purchase options.
Landlords should anticipate that impacted tenants will drive for more flexibility in their lease terms including options to purchase, ROFR’s and likely a drive for shorter term leases.
Window for an Exit Strategy
Rural energy markets can be challenging when looking to sell, even cash flowing investment properties. Those tenants impacted by this rule with 3+ years left on a lease term may consider a purchase option.
Facilities getting in the way of operational production is never acceptable in the energy industry. While leasing is generally the preferred method in rural energy market real estate, now more than ever it is important to assess each facility and the market to determine what makes most sense for your operations and balance sheet.
- Generally, energy companies don’t like to dabble in the real estate ownership game. It’s typically not the highest and best use (or return) of capital.
- Access to cash/capital might make buying seem like a better option, but it’s a strategy that should only be considered on a market by market basis.
- You are in a location(s) where you anticipate a long-term presence.
- The lease value exceeds the purchase price.
- The facility requires a specific and expensive construction/improvement plan.
- It’s a landlord friendly market where long-term leases are required. Keep in mind that landlord friendly markets generally lack supply and offer sound real estate investments over the long-term.
To fully understand the implications of IFRS 16 landlords and tenants should contact either an internal finance department or an outside accounting professional. Additionally, here are a few quality resources that go in-depth into the new accounting standard.
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