Copyright: David Lawson appeared Property Week Sept 1998Home page
The property industry has long despaired about the way bricks and mortar play a minor role in occupiers' financial planning. That could be about to change. An obscure bruiser called FRED is set to kick holes in a thousand profit & loss accounts and bring property costs to the boardroom table. That could add force to the trend towards shorter leases as directors are made more aware of the consequences of taking on property.
Accounting rules are set to change, forcing occupiers to make provision for onerous leases - usually buildings sub-let by occupiers at less than market rent. 'This has the potential to take billions out of the balance sheets of some companies,' says Mike Ringer, managing director of Fraser Trust, a specialist property manager.
A study with a major accounting practice showed 88m sq ft of potential surplus property across the UK with a capitalised liability of 18bn pounds.
Occupiers have been burying their heads in the sand - particularly since the recession, he says. Technological change and shrinking turnover has left many buildings surplus. Even when sub-let they may not cover costs, as passing rents can be lower than the amount agreed with a landlord. Occupiers are stuck with these liabilities for years because owners refuse to take them back. Why should they, when they would make lower returns?
Losses hidden among general running costs will now be exposed. FRED 14, one of a series of Financial Reporting Exposure Drafts from the Accounting Standards Board is likely to mature into a full standard within weeks. This is expected to recommend that companies spell out costs in their annual accounts.
The biggest impact will be on 'people' companies, where property is a large part of total costs, and those which took on leases at the peak of the market, says Carolyn Tobin, director of Corporate Consulting at DTZ Debenham Thorpe.
Insurance and banking, which have sloughed off property since the boom are two potential danger sectors, with the Fraser Trust study showing 4bn of capital liability. But any area still dogged by over-renting will be affected. Sketchley found a 5m pound hole in its accounts last year from a shortfall in rents from branches sub-let as part of a property clearout. This helped turn an expected 8m pound profit to losses of more than 4m.
Tobin's own firm exposed its own property downside when Debenham Tewson & Chinnocks Holdings took a one-off hit of 1.14m on last year's profits as a provision against onerous leases. Analysts may have to look a lot closer for the cost to bigger companies, however. Profits normally have to be cut by more than 10% before directors are expected to give an explanation.
In fact, the companies themselves are unlikely to realise the impending crisis. 'No-one seems to be focusing on this,' says Tobin. 'People don't think about accounting changes until they happen.'
When it sinks in, property could be pushed to an unaccustomed place at the boardroom table as directors begin counting costs. A surge of valuation work seems likely for buildings which have been ignored for years.
But Ringer says the property industry is not geared to handle this crisis. He helped set up Fraser Trust specifically to handled assets which had declined into liabilities for 'reluctant landlords'.
'Many companies do not have a director with detailed property experience, and main boards may be unaware of the real extent of their obligations,' he says.
But property professionals could also struggle because they are not used to handling cashflow liabilities. 'It requires skills more akin to accounting principles or risk analysis,' he says.
One major impact could be to spotlight the kind of short leases promised for almost a decade and now being proposed by incoming US investment trusts.
'As businesses fully appreciate the potential impact on profits of holding surplus property, it is likely that there will be increased resistance to acquiring leases longer than a reasonable business planning timeframe,' says Tobin.
'Reasonable' would normally be five to 10 years, so the US investors may find themselves pushing an already opening door.
[Source: DTZ Debenham Thorpe]
FRED has several brothers expected to cause fear and trembling while stamping around the property industry. One is aimed at joint ventures which shift assets off the balance sheet. British Land, for instance, will find its deals with companies like Rank and Tesco come back into the main focus of the accounts under Financial Reporting Standard 9, which affects accounts with year-ends from last June. The aim is to ensure that heavy borrowing on the assets in these ventures is adequately reflected in each partner's overall gearing ratio.
FRS 11 was published in the summer, requiring companies to write down property that falls below its cost. This affects companies with December year-ends.
Next in the queue is FRED 13, who is expected to kick lumps out of property companies themselves after maturing into a full accounting standard next spring. They will need to provide the current value rather than historic cost of borrowings. This could have an important impact on net asset values - just at a time when they have been savaged by bearish analysts.