A Revolution on the Balance Sheet

Transcription

1 A Revolution on the Balance Sheet The Overhaul of Lease Accounting July 2015 kpmg.co.uk

2 A NEW RISK ISSUE FOR THE BOARD Looming changes to lease accounting will have significant ramifications that boardrooms need to carefully consider and plan for. These include: Higher assets and liabilities on the balance sheet Impact on net profit and earnings per share Sale and leasebacks coming onto the balance sheet A host of tax treatment questions Potential lowering of property portfolio valuations The need for effective communication to investors In effect, it s a new risk issue that Boards need to add to their active list now. Here, we take a detailed look at this approaching collision of accounting and real world impacts KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

3 A REVOLUTION ON THE BALANCE SHEET / 01 CONTENTS THE OVERHAUL OF LEASE ACCOUNTING 02 RETAIL SECTOR OVERVIEW TAX DEBT AND FINANCING BANKS VALUATIONS WHERE DO WE GO FROM HERE? KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

4 THE OVERHAUL OF LEASE ACCOUNTING / A REVOLUTION ON THE BALANCE SHEET / 02 A REVOLUTION ON THE BALANCE SHEET THAT WILL BE FELT IN THE REAL WORLD THE OVERHAUL OF LEASE ACCOUNTING It s been talked about for many years. For so long, in fact, that many people have probably stopped listening. But now, it s actually going to happen. And the ramifications will be extensive and significant. The mission to bring leases on balance sheet is finally nearing realisation. In March this year, the IASB and FASB announced that they had finalised their discussions on lease accounting and instructed their staff to begin drafting the standard, which is due for publication this year (though we don t yet know exactly when, nor which year it will take effect from). They also gave a flavour of what the standard would mean: an increase in assets and liabilities on the balance sheet improving the transparency of a company s leverage and asset base. So what does this mean for real estate in practice, and why will it matter? 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

5 03 / A REVOLUTION ON THE BALANCE SHEET / THE OVERHAUL OF LEASE ACCOUNTING ASSET-RICH BUT MORE INDEBTED At the simplest level it means that the accounting treatment of leases for lessees (tenants) will change fundamentally. Bringing leases on balance sheet means that, whereas currently rentals flow through the P&L on a straight line basis over the life of a lease, in the future leases will be accounted for as if the company had borrowed to purchase an interest in the building (or whatever it is they are leasing). The lease becomes an on balance sheet liability that attracts interest balanced by a new asset on the other side of the balance sheet. In other words, lessees will appear to become more asset-rich but also more heavily indebted. Leases will be treated like an amortising loan in that there will be higher interest payments in the early years, with more capital being paid off in the later years. So, particularly in the early years of a given lease, profits will be depressed compared to the current accounting, and companies will record lower earnings per share. Notwithstanding any smoothing effect across a portfolio, this will also apply to growing companies with multiple leases. Illustration 1 on page 5 shows the impact on the profit and loss account of the new standard over the term of a simple 10-year operating lease. For major renters of property retailers, leisure companies, banks and companies that lease other things such as planes, vehicles and machinery, this raises some significant issues. And of course, it will have many knock-on effects. SHORTER LEASES, MORE BREAK CLAUSES Firstly, it is likely to mean a move towards taking on shorter leases or leases with break clauses in them because a shorter lease will mean a lower liability on the balance sheet (as potentially will a break clause). Illustration 2 on page 7 shows how the opening balance sheet liability on a ten-year lease could be reduced if the lease included a break clause in year five that the lessee was expected to exercise. One of the potential quirks, however, will be that turnover rents based on the size of the company s turnover and therefore variable will not be subject to the new rules. The turnover rent will be treated in line with current GAAP and remain off balance sheet. So we could see a rise in demand for turnover rents, or the bifurcation of leases into a fixed part and variable part, subject to two different types of accounting. Illustration 3 on page 11 shows the impact on the opening balance sheet liability of changing the proportion of fixed and variable rentals while the expected rental remains the same. From the lessor s (landlord s) perspective, while the new standard will have only a limited impact on their own accounts, they will need to be prepared for their tenants and customers to begin this push for shorter leases with more contingent rents KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

6 THE OVERHAUL OF LEASE ACCOUNTING / A REVOLUTION ON THE BALANCE SHEET / 04 THE LEASE BECOMES AN ON BALANCE SHEET LIABILITY THAT ATTRACTS INTEREST BALANCED BY A NEW ASSET ON THE OTHER SIDE OF THE BALANCE SHEET. CASH AND DEBT CONSIDERATIONS There will also be an impact on sale and leasebacks, which have been hugely popular as a way of raising cash and moving assets off balance sheet. Under the new rules, the asset will remain on the balance sheet. There will no longer be an accounting advantage to sale and leasebacks, so the actual merits of the deal itself will become the prime consideration. There could be debt and financing implications too. The increase in liabilities on balance sheet could potentially endanger debt headroom and result in covenant resets being required if they are not on a frozen GAAP basis. No small matter for any company where it applies. A PRACTICAL CHALLENGE On a practical level, there will be real challenges for many companies simply to gather all the information they need to apply the standard information on every single lease they hold. Many organisations won t have all the information in one place. They will also have to make new estimates such as the discount rate to use which will be crucial in calculating just how big the liability will be. A key early decision will be to decide how to move to the new standard. Do you go back to the beginning of every lease to calculate the liability? Or take advantage of an option to use current period information, which will cut costs but distort trend data in future years? For FD s, it may feel like a lot of hard work for no real benefit producing numbers that they just don t recognise. The principal beneficiaries will be analysts and investors. They already make their own adjustments for leases so it will be interesting to see if their estimates tally with the numbers that a company produces. If not, there could be plenty of headscratching and debate. DIFFERENT UNDER US GAAP This seemingly academic accounting change, therefore, will have many and considerable ramifications in the real world. And just to make life even more interesting, FASB will be taking a somewhat different approach from IASB. For companies reporting under US GAAP, the impact on the reported debt will be the same, but there will be no change to the current P&L. All in all, it s going to be an interesting ride. Brian O Donovan, Partner, International Standards Group 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

7 05 / A REVOLUTION ON THE BALANCE SHEET / THE OVERHAUL OF LEASE ACCOUNTING ILLUSTRATION 1: P&L IMPACT OF NEW IFRS INTEREST EXPENSE UNDER NEW STANDARD AMORTISATION EXPENSE UNDER NEW STANDARD ASSUMPTIONS YEAR LEASE 2. RENT OF 100,000 PER ANNUM 3. DISCOUNT RATE OF 7% COMPANY S EXPENSES ( ) 120, , ,000 49,000 71, ,000 45,000 71, ,000 41,000 71, ,000 37,000 71, ,000 33,000 71,000 99,000 28,000 71,000 94,000 23,000 71,000 89,000 18,000 71,000 83,000 12,000 71,000 77,000 6,000 71,000 RENTAL EXPENSE UNDER CURRENT STANDARD FOR ILLUSTRATIVE PURPOSES ONLY YEAR 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

8 RETAIL SECTOR OVERVIEW / A REVOLUTION ON THE BALANCE SHEET / 06 RETAIL SECTOR OVERVIEW A RETAILER MAY BE NERVOUS ABOUT SIGNING UP TO A 20 YEAR LEASE WHEN THEY DON T KNOW HOW GREAT THE DEMAND WILL BE FOR PHYSICAL STORES IN FIVE OR TEN YEARS TIME. Changes to accounting for leases on property come at a time when many retailers are already asking themselves what the role of the store should be. The increasing trend among consumers to shop online, and the ever-growing sophistication of mobile technology, mean that the store itself is being challenged. Property is a retailer s biggest fixed cost. Rentals together with business rates can represent around 15% of sales more than staff costs, which may be in the region of 8-10%. So a retailer with, say, 600 stores nationwide may be asking itself whether in fact 400 would do, or 200 especially if they have a good website which already gives them UK (and worldwide) coverage. With the role of the store currently being reassessed, rechallenged and rebased, the power at the moment generally resides with the shopkeeper rather than the landlord - apart from in really prime, flagship locations. As a result, a move towards shorter leases has already started even before these accounting changes come in. A retailer may be nervous about signing up to a 20 year lease when they don t know how great the demand will be for physical stores in five or ten years time. The new accounting standard for leases won t change things per se but it will bring all of a retailer s lease obligations onto the balance sheet and make them visible to stakeholders. This means that, aside from the accounting and financing considerations, one of the most important things will be communication. It will be vital that retailers communicate clearly what the changes mean. Otherwise, stakeholders from banks to credit insurers to suppliers may take fright at the sudden appearance of obligations that just didn t appear to be there the year before. Retailers will need to anticipate who might look at the new information and what they ll read into it and work out how to get a clear and simple message across to them. The new disclosure will also mean that the average lease length across a portfolio will be visible, so that analysts and investors can compare between different retailers. This will be an important change, because such direct comparisons weren t possible before. If company X s leases are 20 years on average while company Y s are 10 years, company X may find itself coming under question from its stakeholders. This will put a new kind of pressure on some retailers, who will need to focus on the clarity of their message to the market. For landlords, meanwhile, the challenge will be to keep retailers leases as long and as non-contingent as possible. David McCorquodale, Partner, Head of Retail Sector 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

9 07 / A REVOLUTION ON THE BALANCE SHEET / RETAIL SECTOR OVERVIEW ILLUSTRATION 2: IMPACT OF A BREAK CLAUSE ON THE BALANCE SHEET 750, ,000 ASSUMPTIONS YEAR LEASE 2. RENT OF 100,000 PER ANNUM 3. LEASE INCLUDES A BREAK CLAUSE AT YEAR 5 4. DISCOUNT RATE OF 7% OPENING LEASE LIABILITY ( ) 500, ,000 0 ASSUME NO BREAK ASSUME BREAK 0 UNDER CURRENT IFRS FOR ILLUSTRATIVE PURPOSES ONLY 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

10 TAX / A REVOLUTION ON THE BALANCE SHEET / 08 TAX Property transactions will rightly be driven by commercial considerations rather than by tax. However, there can be significant tax costs in property transactions so it is important that tax is fully considered. With the new standard likely to depress net profits for many, especially in the early years, there will also be a lower overall corporate tax bill. However, the standard could see companies deciding to exit some of their leases but where a tenant pays to surrender a lease it can be very tax inefficient as the payment will not be tax deductible. The landlord however will be taxed on the income they receive. A major area of tax relevance will be around sale and leasebacks. In the light of the new standard, some companies may consider unwinding some of these arrangements. They could do this by paying to surrender the lease, but then we are in the tax inefficient scenario above (though this is not necessarily a reason not to do it). If instead the company opts to buy the freehold in the property again, then stamp duty land tax (SDLT) will be payable at 4% of the purchase price - which can be a significant sum. A much more tax efficient way of doing this can be to acquire a company that owns the building or buildings, as then the rate of SDLT is only 0.5%. However, that requires a company to be formed that the tenant wants to buy and certainty around what else is in that company. Forward planning is important here. For example, SDLT group relief is not clawed back if a property owning company is sold by a group at least three years after the property is transferred into it from another group company. Capital allowances should not be forgotten, as they can be kept by the business or used to leverage more value out of the transaction. Tax relief on plant and machinery is transferable between the purchaser or the vendor so it is important that they agree between them who will get the value for what. Then there is VAT, which a purchaser can elect to pay in order to be able to recover VAT on other related costs. There is the potential for significant tax leakage or tax savings around property. With the issues that the new accounting standard will create, it s important that companies don t ignore the tax implications. They need to ensure that they properly consult with their own tax manager, and get expert outside advice too on some of the very complex issues that will require planning and forward thinking. Nicola Westbrooke, Partner, Tax 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

11 09 / A REVOLUTION ON THE BALANCE SHEET / TAX THERE IS THE POTENTIAL FOR SIGNIFICANT TAX LEAKAGE OR TAX SAVINGS AROUND PROPERTY KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

12 DEBT AND FINANCING / A REVOLUTION ON THE BALANCE SHEET / 10 DEBT AND FINANCING WITH THE INTEREST COMPONENT OF THE LEASE PAYMENT HIGHER IN THE EARLY YEARS OF A LEASE, THERE COULD BE A KNOCK-ON IMPACT ON NET PROFIT AND EARNINGS PER SHARE (EPS). Changes to lease accounting could have some significant debt and financing implications for both tenants and landlords. For tenants, it will bring a liability onto the balance sheet that investors and analysts had already factored in and made their own adjustments for, but often from quite imperfect information. Now, analysts will see the company s reported numbers, supported by detailed additional disclosures. Whether this will look better or worse than before will partly depend on a company s lease position at the time the new standard comes in and the assumptions previously made by the market. With the interest component of the lease payment higher in the early years of a lease, there could be a knock-on impact on net profit and earnings per share (EPS). Although nothing will change from a cash perspective, from a P&L perspective it will, and analysts frequently focus more heavily on the P&L than the cashflow statement. Sale and leasebacks are an area that many might reassess. One of the main reasons for entering into them (to move assets off balance sheet) will no longer hold true. Some companies may leave them alone, judging them to be too complicated to unwind, but others may want to do something about it. The key questions will be, if we do something else what would it look like and how would we fund it? And how would investors view that? Many companies may want to reach a more balanced property portfolio that includes some freehold. Advice on matters of capital raising and investor perspectives will be important here. As far as existing bank loans and financial covenants go, issues could arise when facilities need to be renewed or renegotiated. Lease adjusted leverage will most likely be higher, with banks and rating agencies calculating it on a more informed basis. For landlords, while there will be few pure accounting implications, tenants wanting shorter leases will mean a risk to their income profile and also a potential risk to property values. A lot will depend on valuers will they value properties down due to shorter leases or break clauses? For all parties it will mean a reassessment of their property and financing strategy. They will need to think closely about what they already have and what they might do in the future. David Reitman, Partner, Corporate Finance and Simon Mower, Associate Director, Corporate Finance 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

13 11 / A REVOLUTION ON THE BALANCE SHEET / DEBT AND FINANCING ILLUSTRATION 3: IMPACT OF TURNOVER RENTS ON THE BALANCE SHEET 750, ,000 OPENING BALANCE SHEET LIABILITY ( ) 500, , , % FIXED RENT 80% FIXED, 20% TURNOVER 50% FIXED, 50% TURNOVER RENT 0 100% TURNOVER RENT FOR ILLUSTRATIVE PURPOSES ONLY ASSUMPTIONS YEAR LEASE 2. EXPECTED ANNUAL RENTAL OF 100,000 WITH DIFFERENT PROPORTIONS OF FIXED AND VARIABLE AMOUNTS 3. DISCOUNT RATE OF 7% 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

14 BANKS / A REVOLUTION ON THE BALANCE SHEET / 12 BANKS THE CHANGES WILL GIVE BANKS PLENTY TO THINK ABOUT BOTH AS TENANTS AND LENDERS. Most banks have a large number of branches, potentially into the thousands, most of which are leased. Therefore, as lessees, the accounting changes could have a significant effect on them. Like other sectors such as retail, many banks have entered into sale and leaseback arrangements, moving their leases off balance sheet as operating leases but these operating leases will now come back on balance sheet. The big difference for banks compared with other industry sectors is that they have to meet strict prudential regulatory capital requirements. However, if the operating leases coming onto the balance sheet are treated as intangible assets, then the current drafting of the prudential requirements would require them to be deducted from capital resources. This would have a significant impact on their Tier 1 common equity and also impact their leverage ratios. So the big question for banks is how the regulators will respond to the lease accounting standard and whether it will carve out such lease obligations from the requirement to deduct intangible assets altogether. Another possible mitigation might be if the regulators treated the leases as fixed assets rather than intangible assets, as then the effect (a 100% risk weighting) would be different from an actual capital deduction. Whilst there is no change in the economic exposure, it might seem harsh if this accounting change were to impact capital levels. But on a strict reading as things stand, that would appear to be the case. How will the regulators decide to treat this? We won t know for some time, as the accounting standard is not due to be published until the end of this year or 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

15 13 / A REVOLUTION ON THE BALANCE SHEET / BANKS perhaps the first quarter of This is not the only accounting standard with capital implications IFRS 9 (financial instruments) will also have an impact, but regulators have not yet proposed any changes to the capital framework to address that standard, so we cannot yet read anything across from that standard to this one. As lessors and lenders, the standard could also affect banks positions with customers. Bringing leases onto the balance sheet will increase some customers gearing and impact key ratios and covenants. As a consequence, banks will need to model and assess the effects of these changes on a customer s credit rating and potentially renegotiate some agreements if covenants are in danger of tripping. Banks will have a lot more granular information on customers liabilities, where before calculations were made on a fairly approximate basis. Some lessors (property companies) have tended to play down the likely implications of the changes on lessees with their banks. However, most likely banks will take a wait and see approach they will need to look at the information as presented in a company s accounts before they can decide exactly what action, if any, may be needed. As with other industries, therefore, the changes will give banks plenty to think about, both as tenants and as lenders. THE BIG QUESTION FOR BANKS IS HOW THE BANKING REGULATORS WILL RESPOND Charlotte Lo, Director, Financial Services and Steven Hall, Partner, Financial Risk Management 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

16 VALUATIONS / A REVOLUTION ON THE BALANCE SHEET / 14 VALUATIONS FOR LANDLORDS, SHORTER LEASES COULD HAVE A NEGATIVE IMPACT ON THE VALUE OF THEIR PORTFOLIOS. Whilst theoretically speaking the accounting changes are likely to push property valuations down, in reality we expect it to be a complex picture that will affect different players in different ways. For landlords, shorter leases could have a negative impact on the value of their portfolios. But this will not be true for all. Prime will still be prime, and we can expect values at the top end to hold. If a vacancy comes up in Bond St for example, or other flagship locations in London and elsewhere in the country, there will always be a queue of prospective tenants and the landlord will still be able to dictate the length of the lease and choose their occupier. But for those companies with portfolios that consist of significant amounts of secondary or tertiary real estate, there will most likely be a downward impact. This is already being seen in relation to some supermarkets. For companies that own or lease significant amounts of property retailers, hotel chains, leisure sector companies their prime concern is likely to be to review their situation including whether to buy back certain freeholds or exit certain leases. Given analysts typically price such trading property operators on the basis that the leases represent a form of debt, we would expect the overall impact on their share prices to be minimal. However, the changes are likely to lead to increased scrutiny of the optimal occupational strategy. Some major listed retailers have used a rental stream approach from their properties in order to top up their pension funds and reduce deficits. But if valuations fall, this may become more difficult. Changes to the balance sheet could also have an impact on cash or perhaps the amount available to distribute in staff bonuses KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

17 15 / A REVOLUTION ON THE BALANCE SHEET / VALUATIONS THE ANNUAL VALUATIONS CARRIED OUT BY SURVEYORS WILL BE VERY IMPORTANT. HOWEVER, COMPANIES HAVE A CHOICE OF HOLDING ASSETS AT ORIGINAL COST OR AT PRESENT MARKET VALUE. We expect the lease accounting changes to have a more significant impact on businesses in the service sector. These businesses are typically people based organisations that rent property and keep light balance sheets. Examples would include businesses in financial services, support services and even call centres. The changes, requiring them to record large assets and liabilities on their balance sheets, will have a significant impact on their financial statements. This may drive changes in their behaviour as they seek to minimise this impact, with a likely preference for shorter leases. There will also be implications for REITs (Real Estate Investment Trusts) as the trend to short term leases will represent a threat to their income and so could hit share prices, particularly as they would be more exposed to the service sector. So we would expect the lease accounting change to be a potential trigger for many property companies and REITs to carry out strategic reviews of their real estate models. The annual valuations carried out by surveyors will be very important. However, companies have a choice of holding assets at original cost or at present market value. Most property companies s hold at present value and so would be affected by falling valuations, but for other companies it varies. Those that are holding at cost may not see an effect from falling values because they are already holding at a lower original value in any case. On individual leases there will also be an impact to a lessee s profit and loss statements over time. This is driven by the fact that the corresponding asset and liability are accounted for with recognition unwinding at different rates: the liability being expected to initially unwind at a lower rate than the asset due to the amortisation profile of the interest bearing liability. This would result in the net asset value (NAV) of the company being lower over the course of the lease, which could impact on certain payments or incentives and e.g. management/ employee compensation, management fees for PE houses etc. The valuation impact of the changes will certainly vary between individual companies depending on where they are in the market and in the leasing cycle. Everyone will need to thoroughly assess the impact on their own business and consider the implications carefully. Mark Collard, Associate Partner, Corporate Finance Valuations Douglas Marvin, Associate Director, Corporate Finance Valuations 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

18 WHERE DO WE GO FROM HERE? / A REVOLUTION ON THE BALANCE SHEET / 16 IN SHORT, THIS IS MORE THAN JUST AN ACCOUNTING CHANGE. IT S A MAJOR DEPARTURE FROM PREVIOUS PRACTICE THAT WILL HAVE POTENTIALLY FAR-REACHING IMPLICATIONS. WHERE DO WE GO FROM HERE? The new accounting treatment of leases will present some significant questions for both tenants and landlords to get to grips with. The changes come at an interesting time, with business rate revaluations also due to come into effect in 2017 but taken off 2015 rental values - meaning that property costs are likely to rise significantly for many tenants, particularly those in London. The looming accounting changes may add to this pressure. If, as we have seen, a major effect of the overhaul is likely to be a desire among tenants for shorter leases with more break clauses, one of the key questions is to what extent supply and demand dynamics will enable landlords to resist that and hold on to the long, fixed leases that drive their financing and corporate value. For the many tenant companies that have entered into sale and leasebacks, the question of what to do about them will be a complex one and, if they decide to unwind them, one of the key issues will be timing KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

19 17 / A REVOLUTION ON THE BALANCE SHEET / WHERE DO WE GO FROM HERE? The best time to do it is likely to be when property values are falling. But at the moment they are generally stable or growing, and where tenants have leases subject to inflation linked uplifts they are currently benefiting from the low inflation environment. On the other hand, a shortage of sale and leasebacks (with long leases to good covenants) could mean that pricing for this type of investment product increases given ongoing institutional demand. So how long should they wait? There may be more creative or innovative sale and leaseback and other models to consider. For example, a major French retailer Casino entered into a significant strategic partnership with an investor with the rent paid calculated at a percentage of the stores retail sales. Similarly in the US, SEARS has formed a joint venture with Simon Property Group to unlock cash from their real estate and Sears has also created its own REIT. For real estate companies, the key will be to understand and respond to what tenants are looking for given these changes. Innovative and quick moving landlords will want to get ahead of the game and anticipate demand. While the changes could be viewed as a threat for some, for others it could also be an opportunity. So what actions will Boards need to instigate as the changes draw nearer? They are likely to include: Gathering data on all leases and in particular when they were executed with the yields and financing costs applicable at the time Reviewing the potential impact of the changes on financing facilities and loan covenants Reviewing options and financing approaches to sale and leaseback arrangements where applicable Considering the most effective way of structuring any property changes from a tax perspective Communicating the effects of the changes to analysts and investors clearly and in good time This will be more than just an accounting change. It s a major departure from previous practice that will have potentially far-reaching implications. For most, whether a retailer, hotel group, real estate company or REIT, it should lead to a thorough review of real estate and financing strategy to ensure that the rationale for the current status still holds good. John Taylor, Associate Partner, Real Estate and Hospitality Advisory ANALYSTS AND INVESTORS WILL ALSO NEED TO MAKE SURE THAT THEY UNDERSTAND WHAT THE NEW FIGURES REALLY MEAN. FOR COMPANIES, IT WILL BE CRUCIAL TO COMMUNICATE IT CLEARLY FROM THE START SO AS TO REDUCE THE ROOM FOR MISINTERPRETATION IN THE MARKET KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

20 Brian O Donovan Partner, International Standards Group T: +44 (0) E: brian.o donovan@kpmg.co.uk Steven Hall Partner, Financial Risk Management T: +44 (0) E: steven.hall@kpmg.co.uk John Taylor Associate Partner, Corporate Finance T: +44 (0) E: john.taylor@kpmg.co.uk Mark Collard Associate Partner, Corporate Finance Valuations T: +44 (0) E: mark.collard@kpmg.co.uk David McCorquodale Partner, Head of Retail Sector T: +44 (0) E: david.mccorquodale@kpmg.co.uk Charlotte Lo Director, Financial Services T: +44 (0) E: charlotte.lo@kpmg.co.uk Nicola Westbrooke Partner, Tax T: +44 (0) E: nicola.westbrooke@kpmg.co.uk Simon Mower Associate Director, Corporate Finance T: +44 (0) E: simon.mower@kpmg.co.uk David Reitman Partner, Corporate Finance T: +44 (0) E: david.reitman@kpmg.co.uk Douglas Marvin Associate Director, Corporate Finance Valuations T: +44 (0) E: douglas.marvin@kpmg.co.uk The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in the United Kingdom. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. OLIVER for KPMG l OM041103A l July 2015