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> Corporate real estate asset managers should make a decision based on a comparative analysis between the treatment of leasing and purchasing under the new accounting standards.
> When new accounting standards are applied, the lessee should have a flexible view of the lease term, considering its impact on the financial statements.
> Landlords should be aware of how the accounting standards affect tenants’ financial statements, in order to improve their position when negotiating lease terms.
> Due to the new accounting standards, sale and leaseback transactions may no longer be as favourable for sellers.
Summary &Recommendations
Judy JangAssociate Director | Research | Korea
+(822) 6325 [email protected]
Real Estate Management Strategy under New Accounting Standards
COLLIERS FLASH OFFICE | KOREA | 23 OCTOBER 2018
IFRS 16
Under the current standards, an operating lease is not presented on the balance sheet, but according to new IFRS 16, an entity should recognize an asset or liability for all leases whether it is an operating lease or financial lease. According to IFRS 16, effective on January 1, 2019, property leases, which are operating leases, should be reflected as debt.
Lease contracts, including real estate lease contracts, are currently accounted for as expenses. However, according to IFRS 16, a new international accounting standard that is planned to be implemented in 2019, operating leases should be treated as liabilities and assets rather than as expenses. Real estate rent, which is recognized as an expense on the income statement, should be reflected as a liability under IFRS 16.
As a result, corporate real estate asset managers and investors should carefully consider their strategies in light of the new treatment of leases on financial statements. Real estate rent is an important part of a property owing corporate’s financial statement, because cash flow fluctuates due to leasing or selling real estate assets.
For example, landlords leasing out a building may increase their debt-to-equity ratios as all future rentals should be treated as liabilities rather than expenses. An increase in a company’s debt ratio can affect its credit rating, and ultimately can affect the company’s liquidity.
If leasing a corporate office no longer carries any advantage from an accounting perspective, it may be more profitable for corporates to buy a building, thanks to the current low interest rates. Therefore as the corporate debt ratio may rise, asset managers should consider their options considering the new accounting standards.
In addition, as the amount of debt will vary depending on the lease term, tenants may require more flexible leases terms. Therefore, landlords also need to understand the accounting standards that affect the tenant 's financial statements, so that they can build a good real estate management strategy. Meanwhile, insurance companies should find strategy to increase their capital to meet the requirements of the IFRS 17.
IFRS 17
When IFRS 17 becomes effective in 2021, insurance companies should assess their liability reserves in the present value, rather then future expected value. As a result, as the amount of reserves to be paid to customers by the insurer increases in the future, the debt of insurance companies will likely rise due to new accounting standards.
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COLLIERS FLASH SECTOR | MARKET | DD MMMMMM 2018
In South Korea, over the past few years, there has been a noticeable trend for retail companies such as Homeplus, as well as Lotte Shopping, to operate their buildings through a sale and leaseback strategy. This strategy has allowed retailers to sell their properties and lease them for extended periods while continuing to use them as stores.
However, after the adoption of IFRS 16, retailers which make extensive use of leases will probably see increases in their reported debt levels and gearing ratios. While the change of accounting treatment should not affect cash flows and therefore in theory should have no impact on corporate value, the retailers’ balance sheets will consequently appear weaker than at present. This may have adverse implications for borrowing covenants and stock prices.
Therefore, it is necessary for companies to carefully consider the impact of IFRS 16 and check the impact on their financial ratios, corporate credit rating, and lending conditions.
Key points for tenants
• Leasing may be less attractive than ownership as under IFRS 16 leases are planned to be brought onto the balance sheet.
• It may be necessary to revise the debt covenants.
• Insurers and asset managers should also consider changing the performance indicators such as lease contract management and financial reporting and analysis.
• The sale and leaseback strategy may well be less advantageous than owning assets outright.
• A scenario analysis based on the different lease terms should be carried out, and flexible contract terms should be also considered, prior to analysing cash flows.
Leasing versus buyingThe impact of sale and leaseback strategy
The new International Financial Reporting Standard (IFRS 16) may also affect office transactions involving sale and leaseback transactions.
Up to now, corporate headquarters buildings have often been sold, with the selling company entering into a long-term lease contract with the purchaser. This is referred to as a sale and leaseback transaction.
Most of the buyers were real estate funds, since the sale and leaseback strategy enabled them to receive fixed rental income over the long term. It is also a appropriate strategy that meets institutional investors' preferred investment criteria, securing stable liquidity.
From the perspective of the selling company, the key advantage of a sale and leaseback transaction is that it raises cash, but allows the company to go on using the building in return for monthly rental payments. Furthermore, 1) any capital gain arising from the sale is recognized in the selling company’s profit & loss account, and 2) the transaction does not increase the selling company’s total debt and gearing ratios because an operating lease is not treated as a form of borrowing.
However, these accounting benefits will disappear under IFRS 16. Sale and leaseback transactions will therefore probably be used less as a tool for boosting reported cash levels or profits, although companies in financial difficulty may have no choice but to carry them out to raise liquidity.
Whether to own or lease property depends not only upon the accounting treatment but also upon many other variables such as the economy, a company’s portfolio strategy, and management’s requirements. However, IFRS 16 will probably encourage companies which can afford to do so to own rather than lease property.
Therefore, corporate real estate asset managers should conduct a rigorous analysis comparing the advantages and disadvantages of a leasing strategy and an ownership strategy for property.
The volume of off-balance sheet sale and leaseback transactions is likely todecrease.
OFFICE | KOREA | 23 OCTOBER 2018
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Office Transactions & Capital Value
Major Insurers’ Property Sales (2017-2018)
Sale of insurance company assetsIncrease in sale of liquid assets by insurance groups
IFRS 17, which is scheduled to be effective in 2021, has a larger impact on the real estate investment market. According to IFRS 17, insurers' liabilities are planned to be assessed on the basis of market value, instead of book value. Thus, when IFRS 17 is applied, the liabilities of insurance companies will increase and the risk-based capital (RBC) ratio, a financial institution's minimum required liquid reserves, will fall sharply.
Domestic insurance companies have been making efforts to bolster their capital. Major insurance companies such as Samsung Life Insurance, Hanwha Life Insurance, Kyobo Life Insurance and Hyundai Life Insurance have been actively selling their properties in the past few years to raise capital in order to comply with the upcoming IFRS 17.
In particular, Samsung Life Insurance sold Taepyeongro Building, SusongTower and Gangnam Metro Building in 2016, along with Jongro Tower in 2015. In 2017, Samsung Life Insurance also sold its Yeoksam Building. Furthermore, over the first half of 2018, the company continued to sell its assets, such as Ace Tower and Daechi 2 Tower.
This year, Hyundai Life Insurance has sold Hyundai Card and Hyundai Capital building in Yeouido to increase liquidity. In addition, KDB Life insurance has raised its RBC rate through the sale of its HQ building. Most insurance groups have sold their headquarters and secured capital by sale and leaseback.
Until now, real estate assets owned by large insurance companies have been sold on the market. But small and medium insurance companies that cannot meet the RBC ratio may become the target of hostile M&A takeovers. On the other hand, IFRS 17 is expected to affect cash flow analysis when evaluating corporate value, by affecting assessment of corporate’s real estate assets.
As the trend of low interest rates and slowing down economic conditions continues, we expect that the sale of real estate properties by insurance companies will continue in the future, in order to prepare for the potential of unsteady economic conditions in the future. Source: Colliers International Research
Source: Colliers International Research
OFFICE | KOREA | 23 OCTOBER 2018
Samsung Life
YeoksamKDB life Ace Tower
Samsung
Daechi 2 Tower
Hyundai Capital
Tower1
Pic.
Market GBD CBD CBD GBD YBD
Area
(py)9,887 24,840 13,136 7.992 11,269
Billion
(Million)
207
(21)
422
(17)
200
(12)
190
(23.8)
180
(15.9)
SellerSamsung Life
InsuranceConsus AMC
Samsung life
Insurance
Samsung Life
Insurance
Hyundai Life
Insurance
Buyer
Samsung SRA Asset
Management
KB Asset
ManagementKG Group
Hanwha Asset
Management
NH Amundi
Asset
Management
0
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1,000
1,500
2,000
2,500
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1
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3
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5
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9
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Cap
ital
Val
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W/P
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1Q 2Q 3Q 4Q Capital Value
About Colliers International Group Inc.
Colliers International Group Inc. (NASDAQ: CIGI) (TSX: CIGI) is a top tier global real estate services and investment management company operating in 69 countries with a workforce of more than 12,000professionals. Colliers is the fastest-growing publicly listed global real estate services and investment management company, with 2017 corporate revenues of $2.3 billion ($2.7 billion includingaffiliates). With an enterprising culture and significant employee ownership and control, Colliers professionals provide a full range of services to real estate occupiers, owners and investors worldwide,and through its investment management services platform, has more than $20 billion of assets under management from the world’s most respected institutional real estate investors.
Colliers professionals think differently, share great ideas and offer thoughtful and innovative advice to accelerate the success of its clients. Colliers has been ranked among the top 100 global outsourcingfirms by the International Association of Outsourcing Professionals for 13 consecutive years, more than any other real estate services firm. Colliers is ranked the number one property manager in theworld by Commercial Property Executive for two years in a row.
Colliers is led by an experienced leadership team with significant equity ownership and a proven record of delivering more than 20% annualized returns for shareholders, over more than 20 years.
For the latest news from Colliers, visit our website or follow us on
Primary Authors:
Judy JangAssociate Director | Research | KOREA+82 2 6325 [email protected]
Andrew HaskinsExecutive Director | Research | Asia+852 2822 [email protected]
For further information, please contact:
Kichoon JungManaging Director | MD | KOREA+82 2 6325 [email protected]
Jaehyon PyonSenior Director | Valuation & Advisory | KOREA+82 2 6325 [email protected]
Joon LeeSenior Director | CMIS | KOREA+82 2 6325 [email protected]
Jay ChoSenior Director | Office Services| KOREA+82 2 6325 [email protected]
Moohwan ShinAssociate Director | Project Management | KOREA+82 2 6325 [email protected]
