+33(0)173101995Interview of Jean-Claude Dubois, Head of BNP Paribas Real Estate Valuation
To what extent will IFRS 16 standard impact the taxation of finance leases?
IFRS 16 will have more of an accounting than a tax impact on the consolidation of companies' accounts. The application of this international standard will remain neutral for lessors. But it will impact the treatment of commitments in the lessees’ balance sheets. Any operating lease contract previously recorded off-balance sheet and equal to or greater than €5,000 must appear on the company's balance sheet. Lease commitments will be recorded as rights-of-use on the asset side and reclassified as debts on the liabilities side. This new accounting approach will initially increase the level of indebtness relative to equity, and consequently degrade the debt ratios of companies.
Under these conditions, could companies change their investment strategies?
Some companies may be tempted to change their strategy from leasing to acquisition. If this is the case, they may have to strengthen their equity capital to acquire an asset, with the bank financing only 60-65% of the investments. Therefore, in order not to reduce their equity ratio in the event of a lease, they could leverage the lease contracts’ duration.
IFRS 16 standard could therefore lead to a reduction in the duration of commercial leases. But everything will depend on the nature of the property considered. On the market of so-called “secondary” assets (both in terms of use and location) such as tertiary sector goods located on Paris second periphery, the balance of power is in favour of tenants. Given the abundant supply, the latter will have to negotiate more traditional rental contracts over a period of 3, 6 or 9 years instead of 9 to 12 years. This does not play into the hands of investors who, for these locations, clearly prefer to commit to long-term fixed leases.
On the other hand, in certain highly sought-after areas such as the central business district of Paris, the trend is towards an increase in the property’s rental value. The vacancy rate in this area is only 2 to 3%, while the equilibrium point is around 7%. In this market marked by the weakness of supply, lessors have every interest in leasing over shorter periods to take advantage of the potential for rent increases. One thing is certain: companies will have to arbitrate between the reinternalisation of real estate through direct acquisition and leasing or operating leases.
Can we envisage the end of leasing contracts?
I don't think so. Firms will first have to evaluate the cost of their return on equity in relation to the cost of their debt before considering the direct acquisition of real estate. If this ratio is higher than the cost of leasing, they will continue to use leasing.
Currently, this is still the case. In a leasing contract, the parties involved are usually the user who rents to an investor who can call on a bank. In the future we could return to an older scheme: the user and the bank. The lessee then becomes the direct operator. Lending banks could also reexamine their positions.
With the entry into force of IFRS16 from 2019, they could ease their lending terms by accepting higher levels of debt on the lessees' balance sheets. But it is still too early to draw conclusions.
Will these changes have any consequences for property valuations?
In markets where demand exceeds supply, investors could demand longer fixed leases and accept lower rates of return than for conventional leases, leading to higher property values. But this trend could be mitigated in certain areas such as Paris' central business district where investors could seek shorter leases to take advantage of rental growth potential.
On the other hand, investors' appetite for the periphery is less sustained due to the general trend towards shorter lease terms. In any case, if lessees decide to reduce the outsourcing of their portfolios in order to acquire goods directly, supply constraints could arise on certain asset classes such as commercial properties. Investors, especially insurers, may then have to turn to other assets such as real estate debt funds. Assets with limited risk, but with more attractive yields than traditional government bonds.
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