LSH discuss how corporate real estate accounting legislation impacts acquisitions

Despite the current economic climate, companies requiring a larger office building are still more likely to procure it via a pre-let agreement than by taking existing office space. However, when you consider the rules and regulations governing occupiers’ corporate real estate accountancy protocols, this is perhaps not that surprising. Leonie Dickman, in Lambert Smith Hampton’s (LSH) Cambridge office explains why.

The legislation pressure comes from the International Accounting Standard 37 (IAS 37) and the Financial Reporting Standard 12 (FRS 12). These dictate that a company’s financial accounts should provide an accurate assessment of the provisions it needs to make to cover the liabilities of non-operational property leases. Worryingly, research suggests that few companies diligently comply with this legislation, and are therefore not showing the true impact of non-operational property on their business.

For some occupiers, the buoyant property market of recent years virtually negated the need to proactively manage surplus property as property disposals and sub-lettings were easily secured, thereby limiting the costs and associated liabilities. However, as the impact of the credit crunch continues to cause turmoil, a vacant and non-operational leasehold property that is surplus to requirements, and where there is no sub-let agreement in place, is a significant problem. This situation fulfils the criteria of an ‘onerous lease’ and must be reported in a company’s accounts, with the provision accounting for the total disposal cost of the lease.

The impact of legislation on property procurement with an impending lease end on an early/mid 1980s office building, a company will take one of four options, the first being to stay where it is and re-gear the current lease. However, given the age of the building, it is inevitable that M&E systems will need replacing with the building itself requiring a major refurbishment. To continue an operational business amidst these extensive works would be nigh on impossible, causing significant disruption to staff and revenues.

An alternative would be to wait until the lease end is a matter of months away before entering negotiations to occupy an existing office building. However, it’s highly unlikely that the exact size, location and layout of building will be available to satisfy exact requirements, let alone a building that is ready to be occupied at the eleventh hour. The associated risks to business continuity are not worth taking, as this option could well leave an occupier out in the cold in an already uncertain market.

With these issues in mind, it is imperative that an occupier takes action on a lease end around two years prior. However, signing a new lease on an existing office building at this stage means that rent and other liabilities on the old premises will run concurrently with those of the new building. And because it’s unlikely that a short, two year sub-let will be agreed on the old premises, it can be assumed that the disposal costs – which must be capitalised in the corporate accounts and taken as an immediate provision – will be the total remaining two year cost of the lease.

Furthermore, while the occupier may receive a landlord’s incentive to acquire their new property, this credit must be amortised (diluted) over the length of the new property lease. The result of capitalising costs and amortising (diluting) incentives is likely to have a negative impact on a company’s current balance sheet, meaning that this option is often, unsurprisingly, resisted by the FD.

The final, and more viable, option is to sign a pre-let agreement at this two year mark. This approach reports a very different story: there is adequate time for a developer to build the property, with design, internal layout and fit-out built to accommodate the occupier’s specific requirements. Furthermore, and most critically, the terms of the pre-let can predetermine a lease start date that dovetails with the impending lease end. The result?  Minimised onerous lease liabilities and a modern HQ building that is tailor-made for the occupier’s business.

Lambert Smith Hampton (LSH)

LSH is a leading commercial property consultancy with an unrivalled national network focused on the UK and Ireland property markets.  Its expert teams deliver a full spectrum of transactional and consultancy services and business-driven solutions for clients.  LSH is the ‘UK’s most active national agent’ and ‘Top National Office and Industrial Agent’ (Estates Gazette’s ‘EGi Deals Competition’).

Lambert Smith Hampton’s (LSH) Cambridge office is a commercial property consultancy providing property services and advice in Cambridge, the surrounding area and nationally. With LSH clients have the added advantage of each office being backed by the strength of a national office network. For clients, this means 10 key divisions and over 850 professional staff working together to address the commercial property difficulties you may face, anywhere in the UK.

Lambert Smith Hampton's Cambridge office is a member of the Elite Cambridge Business Circle.

6 Wellbrook Court
Girton Road
Cambridge
CB3 0NA
UK

Tel: + 44 (0) 122 327 6336
Fax: + 44 (0) 122 327 6226

http://www.lsh.co.uk

For more information contact:
Andrew McGahey
Director, Head of Cambridge Office
Lambert Smith Hampton

Tel: 01223 276336
Email: amcgahey@lsh.co.uk

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