REAL ESTATE

Retailers face six-month countdown until lease accounting changes take effect

BY Imran Mia

The retail industry is riding waves in unprecedented stride. By now, the challenges faced by retail organizations are well-documented: Changing consumer demands and the growth of digitization are topics that have dominated the headlines and preoccupied the c-suite as they look toward an increasingly unknown future. In the distance, a new wave of significant financial reporting changes is soon to arrive at full force, in particular for those who have yet to comply.

The imminent arrival of new lease accounting regulations is set to “bring leases to balance sheet,” requiring retail operators to recognize and report almost all leases — with the exception of low-value asset leases and short-term leases lasting less than 12 months — as assets and liabilities once IFRS 16 and ASC 842 come into force in January 2019. The objective of the new standards, which were established by the International Accounting Standards Board and Financial Accounting Standards Board, is to improve transparency, comparability, and financial reporting, but the process requires a significant amount of attention to be paid to ensure the demands of compliance are met without penalty.

Retailers have been relying on lease arrangements as a cost-effective strategy to invest in stores, point-of-sale systems, distribution centers, and transportation equipment, so the impact of the new standards on retail operators does not come without weight. It is estimated that at least 35% of global retail entities will see an increase in debt of over 25% according to a PwC report, with a median increase in debt of almost 100%. By bringing leases to balance sheet, the implementation of new leasing standards may expose billions of dollars in lease liability across the industry.

Creating an articulate and responsive lease accounting model has long been a crucial pain point for retail operators. The new reporting requirements add a new layer of complexity, in particular in the following ways:

Leases for retail space are often structured with a series of renewal options that provide the retailer with operating flexibility. In a change from previous accounting standards, the exercise of renewal options now triggers a possible reassessment of the lease’s operating versus financing classification, which would also involve a revaluation of the right-of-use asset and related lease liability.

Retailers increasingly rely on outsourcing arrangements for non-core functions, such as warehousing operations and data center hosting. Some retailers have set up shop within other businesses to operate “store-within-a-store” concepts.

Under the new requirement to record leases as assets, retail operators must now evaluate these arrangements to determine whether they contain a lease contract or constitute an embedded lease. In the latter case, retail operators will need to separate the lease component from the service contract, and record the asset and liabilities for the lease component.

• Retail insiders have become familiar with the financial implications of sale-leaseback transactions and build-to-suit contracts. Under the new lease accounting rules, not only will retailers need to change their back-office processes, but decision-makers will need to adapt their expectations on how these transactions affect financial statements. Retailers with dual reporting obligations under US GAAP and IFRS will face further complexities because accounting for these common arrangements differ from ASC 842 and IFRS 16.

Under the new standards, retail companies will require access to accurate and real-time leasing data to identify the values, payments, and depreciation of leases, and to produce the required disclosure reports. Working out discounted cash flows to calculate lease liabilities and right-of-use assets without specialized software can be extremely difficult to do at scale.

However, the corporate accounting team can diligently manage the challenges and achieve compliance without sifting through spreadsheets of duplicate or missing information by adopting lease management and accounting technology that centralizes data and automates accounting. Lease administration technology can help to identify everything that meets the definition of a lease, determine if contracts meet any exemptions, streamline accruals, payments, or reconciliation, and publish necessary disclosures.

Effective lease management and administration extends beyond the imminent compliance deadline. By establishing a leasing administration ecosystem, companies thinking beyond short-term compliance will find it possible to parlay the requirements of compliance into strategic operational decision-making.

For most retail organizations, the implementation of IFRS 16 and ASC 842 will mark the first instance where they hold centralized and organized leasing data. As they gain a clear view of leasing assets and liabilities, companies can then derive the data-driven insights needed to cut costs and streamline supply chains.

Early adopters are already leveraging a centralized lease database to identify long-forgotten leases, shed liabilities, and consolidate lease terms for more favourable contracts. In a world where retail winners depend on increasingly lean-and-mean operations, comprehensive data and clear decision-making on leased assets could prove key to long-term strategic success. The road to compliance could be long, and is definitely mandatory, but it is undoubtedly worthwhile.

Imran Mia is a lease accounting expert at enterprise software provider Nakisa, which works with world-leading organizations to plan, transition, and comply with new leasing standards and financial regulations. 

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REAL ESTATE

Retail rents rise in this market

BY Marianne Wilson

Tenant growth and limited construction have combined for a drop in retail vacancy in Phoenix.

Net absorption of retail space in Greater Phoenix surpassed 500,000 sq. ft. for the second quarter in a row, which signaled continued improvement for the market, according to real estate services and investment management company Colliers International. Limited construction of new space and tightening vacancy forced rental rates up during the last three months.

“The limited addition of new space means that new and expanding retailers are backfilling vacant space,” said Pete O’Neil, research director with Colliers International in Greater Phoenix. “This trend is helping the market recover from recent closings of national retailers as that space is re-purposed.”

The total net absorption for the first half of 2018 is up nearly 10% over the absorption posted during the first six months of 2017.

The total net absorption for the first half of 2018 is up nearly 10% over the absorption posted during the first six months of 2017.

The retail vacancy rate dipped to 7.6% in the second quarter, which is 130 basis points below mid-year 2017. The rate has been trending lower for the past 18 months and is now at its lowest point since mid-2008. Some of the strongest vacancy improvements have been experienced in the East Valley and Scottsdale submarkets.

Rental rates rose to $14.99 per square foot in the second quarter, which marks a 3% rise in the past 12 months. Asking rents in the East Valley rose to above $15 per square foot for the first time since 2010. These rates are up 4.6% from one year ago.

The strong first half of 2018 signals what Colliers believes will be a robust remainder of the year. Traditionally, Phoenix posts its strongest retail performance during the second half of the year. As the economy strengthens and the health of the local housing market continues, consumer spending is expected to rise and support local retail real estate. Investor demand and transaction volume of shopping center sales are expected to be steady since cap rates have remained relatively flat in the environment of rising interest rates.

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Blink Fitness pumps up expansion plans with 17-unit lease agreement

BY Jennifer Setteducato

While some retailers are shuttering doors, fitness chains are hardly breaking a sweat as malls and shopping centers are leveraging them as anchors to increase foot traffic.

Blink Fitness – a value gym brand that will have approximately 85 locations open and operating by the end of 2018 – and Seritage Growth Properties have formed a multi-property lease agreement that will bring 17 corporate and franchisee-owned gyms to major metropolitan areas across 10 states as part of the chain’s aggressive expansion plans.

Seritage is the publicly traded REIT that releases and redevelops Sears and Kmart stores.

“We are very pleased to establish this mutually beneficial relationship with Blink Fitness, a brand that exemplifies the differentiated, growing and in-demand retail concepts that are joining our national portfolio,” said Benjamin Schall, president and CEO of Seritage Growth Properties. “This lease is a perfect example of how our national portfolio can provide retailers unparalleled access to prime real estate in high growth markets.”

Blink Fitness plans to enter additional markets, including Georgia, Illinois, Massachusetts, Michigan and Virginia, over the next year or so, according to CEO Todd Magazine. He expects Blink to surpass the 300-unit mark over the next five years, with strategic multi-unit real estate deals helping drive this rapid growth.

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