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UK occupiers face adding 200bn of property leases to balance sheets

  • Regulatory changes mean property leases need to be reported in financial statements
  • Changes brought in to drive transparency and comparability

UK occupiers will be forced to add nearly £200billion of commercial property lease liabilities to balance sheets, according to estimates from Cushman & Wakefield, following new rules brought in by the International Accounting Standards Board (IASB).

Under current arrangements, companies do not have to recognise the majority of lease liabilities for property on their balance sheet.

However, following concerns over financial transparency, the IASB has issued new rules on lease accounting, in the form of IFRS 16, which came into force at the start of this year. Companies now have three years in which to comply with the changes.

Based on IFRS figures that 85% of leases commitments are currently ‘off-balance sheet’, Cushman & Wakefield believe this could see UK companies having to recognise an estimated £200bn of property lease assets on their balance sheet within the next three years.

Paul Fry, Partner in Cushman & Wakefield’s Occupier Finance team, said: “Under the new rules, occupiers with large portfolios of leased assets will see a significant increase in their balance sheet. The changes have been brought in due to a lack of transparency and comparability. The information on operating lease liabilities currently declared within financial statements is insufficient for analysts, credit rating agencies and investors to be able to draw a clear picture of a company’s financial health.

“The impact for the majority of occupiers is expected to be modest; two out of three occupiers can expect a change in profit margin before tax of less than 1%. Nonetheless, this will vary by sector and for companies with a low profit margin, such as retailers, the impact is expected to be more significant. As an example, Tesco’s net debt is expected to increase from c. £8.6bn to c. £17.6bn, an increase of more than 100%.”

Overall, the financial statements for airlines, retailers and travel and leisure operators are expected to be most impacted. For these three sectors, the present value of lease commitments is estimated to be greater than 20% of their total asset base.

In contrast, healthcare providers, information technology companies and distributors are expected to be least impacted. These sectors have lease commitments which equate to less than 5% of their total asset base. For financial institutions, including banks and insurance companies, the changes may have an impact on their Regulatory Capital requirements, as they will report higher assets and lower equity.

Hannah Coleman, Associate in the Cushman & Wakefield Global Occupier Services team, said: “For most companies, the new rules will require a step change in the way commercial real estate engages with the wider business. Corporate Real Estate teams can also expect greater focus from the wider business on property strategy and the negotiation of lease terms.

“The new regulations mean it is imperative that companies maintain detailed records for individual leases. Data updates will need to be made at all lease events including indexation, rent reviews, service of notices and even lapsed notice periods.”