What does IFRS16 (Accounting for Leases) mean for companies using Flexible and Serviced Offices?

The new accounting standard came into force for quoted companies on 1st January 2019. Much has been written about office occupiers becoming “IFRS16-ready”, but what impact will it have on those tenants in flexible and serviced offices?

Under the new standard, pretty much all property leases of 12 months or more should be included on-balance-sheet. In Profit & Loss terms, this means they are front-loaded (P&L cost is much higher in the early years of a lease than in the later years), and the balance sheet will look more debt-laden, with an increase in gearing. In the serviced office world, most licences are 12 months or less, which therefore has implications for quoted companies using serviced offices within their real estate portfolio.

Many corporate firms, as part of their real estate strategy, have used serviced offices in a core and flex approach. This method has been around for decades however, it is becoming increasingly popular, whereby elements of a portfolio is on a long term lease or even owned (core space), while for projects, regional HQs or smaller offices, they use flexible offices (flex space). We are seeing more and more portfolios shifting towards a higher proportion of serviced and co-working space. In this context, what is the potential impact of lease accounting?

Under IFRS16, the company’s intentions become a part of the accounting treatment. If a lease is approaching an end – or if it is a short-term agreement – the accountants will take a view on whether it is the company’s intention to remain or relocate in order to determine the appropriate accounting treatment.

Where serviced office leases are deemed to be on-balance-sheet, it will be important to separate the underlying rent from the cost of services – services and property taxes will not typically be treated as rent for the purposes of accounting for the leases.

The flexible and serviced office market may well provide a solution to IFRS16 through offering space as a service or even with agreement-lengths at less than twelve months.  Companies wishing to use this strategy will, however, need to have a corporate policy of undertaking a comprehensive review process prior to the notice date of each such short-term agreement, allowing enough time and having sufficient intent to consider moving.

Firms will need to ensure they can legitimately say that their flex space is more commoditised and short term than leases covered by the accounting standards. Without such attention to managing the contractual duration of serviced offices, the agreements are likely to be found to be leases for the purposes of IFRS16 and, depending upon the corporate accounting policy, may be assumed to last for a few years.