New accountancy treatment for leases seems inspired by symmetry rather than logic
I thought that somebody would eventually get round to thinking about the landlord. Almost all discussion of the proposed new accounting treatment of leases from Britain’s Accounting Standards Board has so far concentrated on the tenant’s position.
If, as is proposed, virtually all leases – including property leases – have to be brought on to the lessee’s balance sheet as an asset and a corresponding liability, the property world will never be the same again. Tenants will no longer be prepared to sign long leases, we are told, because a long lease means showing a bigger liability than a short one – the liability they would need to show is the discounted present value of his payments over the life of the lease. And not many companies like bumping up their liabilities and, consequently, their published gearing ratio.
So far, so good (or not, depending on your viewpoint). But if the tenant shows a liability, shouldn’t the landlord show a corresponding asset? This, at least, was the thinking behind the new accounting proposals, as they would affect the landlord’s accounting. But the landlord already shows an asset, the property industry says. He shows the property that he owns, at its market value, as required by the present accounting standard: SSAP 19. It is a thoroughly sane and sensible way to account for investment properties. Why change it?
But this was not good enough for the accounting trend-setters. In reality the landlord has two assets, they argue. He has the right to the rental payments he will receive under the lease that he has granted, which is pretty much the mirror image of the obligation to make payments that the tenant shows. Beyond this, he has his residual interest in the property. So, instead of showing a single figure for the property, he should break it down into these two different elements. Presumably the total would be market value, as before. But then he’d need to deduct the value of the lease to arrive at the residual value of the property, and show the two separately.
BPF defends status quo
The British Property Federation (BPF), unsurprisingly, doesn’t like this at all. In an update for its members, summarising the submissions that it has made to the Accounting Standards Board, it argues that splitting the property into the two elements proposed would contribute very little useful additional information. If the object is to show whether the property value is underpinned by the property itself or is more reliant on the rental stream (as with an over-rented property) it would make sense to require a vacant possession valuation.
I have some sympathy with the BPF’s views. I suspect that the proposed accounting treatment for landlords may have been inspired more by the apparent symmetry of mirroring the tenant’s position than by any compelling logic.
But I feel that the BPF is on shakier ground in some of its detailed reasoning. It suggests that the proposed treatment would be relevant in accounting for depreciating assets but it should not be applied to investment property because investment property “is expected to be an appreciating asset and consequently there is no need to apportion any element of rent as back-door depreciation”.
Buildings wear out
The real problem here, to my mind, is that buildings are a depreciating asset. They wear out or become obsolete and they need to be refurbished or replaced. Capital tied up in the buildings is being consumed, and it would be reasonable to acknowledge this by providing depreciation. The land on which the buildings sit, however, is not a depreciating asset. Its value may go up or it may go down but this is for different reasons. The land itself does not wear out. Hitherto, the fall in the value of the building has generally been masked by the rise in the value of the land. The yield on which the surveyor values the property as a whole reflects these two elements without specifying them. It will tend to rise as the building reaches the end of its working life.
Yes, you can argue that a tenanted investment property consists of two elements: the value of the lease and the residual value of the property. But far more useful, to my way of thinking, would be to make a different split: between the value of the building structure and the value of the land that it sits on. Again, these are separate investments. One needs depreciation, the other does not. In one, capital is being consumed, in the other it is not. The value of the building relative to the land will tell you a lot about how long it is likely to remain income-producing. That would be really useful information for the investor.
