The two main accounting standards bodies globally have made a preliminary decision to exclude all investment property lessors from a proposed major overhaul of rules for how businesses recognize lease transactions, the European Public Real Estate Association (EPRA) says.
The International Accountancy Standards Board (IASB) based in London and the Financial Accounting Standards Board (FASB) for the US, have decided to also leave out companies that measure their investment property at cost from the new regulations, in an extension to a previous decision to exclude those who measure their property at fair value.
Gareth Lewis, Director of Finance at EPRA said: "This preliminary decision represents a vindication of the representations made by EPRA and our global partners within the Real Estate Equity Securitization Alliance (REESA) to the IASB and FASB. A major concern with the previous proposal was that it failed to recognize the unique characteristics of owning and leasing investment property where the asset is viewed in its entirety, rather than as the in-place lease and a residual asset. The passage of the original proposals could have been very damaging to the listed real estate industry globally."
The proposed new rules for lease accounting would have dramatically changed the way real estate companies account for their property. Every time a property company entered into a lease, it would have been treated as selling a portion of the property and recognized amounts due under the lease as a financial receivable. The company would have no longer showed rental income, but interest and profit on the 'sale' instead.
Lewis said that the decision is likely to have more impact on listed real estate companies in the US and Asia, where fair value reporting is less established and many property companies report properties at cost. This contrasts with the situation in Europe where over 95% of companies in the EPRA index are already reporting property at fair value in accordance with the EPRA Best Practices Recommendations.
EPRA and REESA have been communicating to the accounting standards bodies for some time that the proposals are inconsistent with how investment property lessors view their holdings and would have presented significant operational challenges. For example, for shopping centers, with hundreds of individual leases, and where determining a value/cost of the leased portion and the residual asset would have in all likelihood resulted in arbitrary figures with no market bearing.
The accounting standards bodies' preliminary decision is expected to be reflected in the revised Exposure Draft on lease accounting, due to be published before year-end.
Another related important topic for European listed real estate companies, are the 'consequential' amendments that will need to be made to the current Investment Property Standard (IAS 40), including whether lease income should continue to be reported on a 'straight-line' basis, or accounted for as cash received.
A move to cash-based accounting would follow a recent FASB decision to require cash-based accounting for rental income in its proposed Property Investment Entities Standard. Under this approach, companies would report no rental income during rent-free periods and higher rent thereafter.
A recent survey of 73* EPRA-member CFOs, investors, and analysts in Europe, showed that a majority (70%) are currently against a move to a cash-based approach. Nevertheless, a sizeable proportion (40%) of the investors and analysts surveyed would support such a move highlighting the mix of views on this issue within the industry.
* Slightly more CFOs (38) were surveyed than investors and analysts (35).
Source: Bellier Financial