Why New Accounting Standards Will Force Real Estate to Get Strategic

New accounting standards will see real estate leases take on an unprecedented significance for company finances, shining a spotlight on the business’s property management technology

For real estate professionals negotiating and signing new leases, life is about to get significantly more complicated. From January 2019, the introduction by the International Accounting Standards Board of IFRS 16, a new accounting standard focused on ensuring the value of leasing obligations is reported on publicly-listed companies’ balance sheets, poses all sorts of challenges.

The rules are likely to see the value of companies’ liabilities and gearing increase significantly according to analysis. That will apply both at the moment of transition, as existing leases are reported on the balance sheet for the first time, but also on a continuing basis with all new leases signed thereafter coming under the new rules.

For the real estate functions of large businesses, therefore, IFRS 16 represents a watershed moment that they may not be equipped to deal with. Businesses without property management technology that includes modules designed to cope with the new rules are likely to find themselves in particular difficulty.

The challenge is twofold. Finance departments have already started putting pressure on their real estate colleagues to identify all leases covered by the new rules and to begin extracting the data required under IFRS 16; for many companies that will be a major undertaking. But just as daunting is the long-term implication of the reforms – now that leases will have such a material effect on the company’s publicly stated financial standing, it will be crucial to consider this issue when entering into new lease agreements.

In other words, real estate functions are going to have to become more strategic in the way they approach new leases; the impact of every lease covered by IFRS 16 will need to be considered in this context. The real estate function may even find that its preferred approach to property leases is no longer in the best interests of the business – and that it therefore needs to change tack in order to optimise future lease design.

To make such decisions, real estate and finance will need to work more closely than in the past – and to exploit property management technology that is capable of modelling the potential balance sheet effects of each new lease under consideration; such models will be the key to identifying the best way to proceed – and therefore to informing the negotiating strategy and priorities for real estate as it discusses new agreements with landlords and freeholders.

If that sounds intimidating, bear in mind too that for many international companies, this modelling process will also have to be able to cope with the different approach taken to lease accounting by the Financial Accounting Standards Board in the US. Its Topic 842 standard, which takes effect around the same time as IFRS 16, is based on identical principles, but works differently from a technical perspective. Businesses covered by this standard as well as IFRS 16 therefore need property management technology that is able to model on the basis of both systems.

The ideal approach will be one that is pursued jointly by finance and real estate, given their respective experience and expertise. Where either function seeks to act in isolation, they risk missing crucial nuances that may have a major impact given that globally, IFRS 16 and Topic 842 are expected to add $2.8trn worth of assets to company balance sheets.

Takeaways:

• New accounting standards that come into force in 2019 will require companies to record the value of real estate leases on their balance sheets
• The effect of these standards will require the real estate function to think more strategically about lease design in future
• Real estate must work in close partnership with finance to manage compliance and deliver strategic goals

For more information on our lease accounting solution, please visit the IFRS 16 page.