The new property leasing standard has left retailers running the rule over their balance sheets and landlords facing shorter lease demands.
What is IFRS 16?
The International Financial Reporting Standards (IFRS) are a set of global accounting standards, and IFRS 16 outlines how companies should report property leases. It replaces the old IAS (International Accounting Standard) 17.
What does it mean for retailers?
IFRS 16 places an obligation on a retailer to account for the entire length of a lease as a liability on its balance sheet. It is used to gain an understanding of what cashflow issues could arise from any lease commitments. The new standard affects reporting periods beginning on or after 1 January 2019, which is why we are beginning to see its impact on retailers’ half-year profits now.
Who has reported on it so far?
A handful of fashion retailers have detailed the costs to date. On 10 September, JD Sports Fashion outlined a £7.6m hit to its profits for the six months to 3 August from the switch to IFRS 16.
Two days later, John Lewis Partnership revealed that IFRS 16 has resulted in a £26.5m fall in its reported profit before tax for the half year to 27 July, although it noted that this “does not change the underlying economics of our business and has no quantitative impact to cash flows”. French Connection also spelled out the impact on its half-year results, released last week.
Why are some retailers more heavily affected?
One property agent tells Drapers the impact of IFRS 16 should be neutral in the long term, but does not always appear that way when companies account for the new measure in their reporting.
“Retailers’ liabilities are the same but they are presented in a different way,” he says. “Depending on the shape of a retailer’s balance sheet, it will affect how they can accommodate the new change. It depends where the pinch point is. IFRS 16 front loads the impact of a longer lease in the accounts, and has less impact towards the end.
“Those with longer leases will appear to have been more affected. We have to be wary of over-reacting to [changes to profits or balance sheets].”
Indeed, experts point out that department stores and supermarkets, which typically have long lease terms on large properties, could appear to be disproportionately affected by the new accounting standard.
Matthew Hobbs, head of retail – lease advisory at Colliers International, says: “For grocers it’s important to have a site to trade from for long periods of time, and they find it hard to find a good new location.
“For example, Tesco used to have a lot of freeholds in the 1970s and 1980s, but it undertook sale and leasebacks [whereby the superstores were sold to investors and Tesco rented them back on long lease terms] to raise cash in their race for space. They were taking 20- or 25-year leases in 2011, so they have a big liability.”
Will this have any wider impact?
Hobbs says retailers are seeking shorter leases as a result of IFRS 16.
“The main change we’ve seen [is that it’s becoming] rare to see a lease longer than five years in the UK, and the 10-year lease with a break after five years is no longer an option. In a market town where rents have effectively been in freefall, you can often end up with a break [clause] after three years.”
While individual retailers grapple with the cost of implementing IFRS 16, it could accelerate the shift towards much more flexible retail property leasing.