Landlord lease definition

Landlord lease definition

Identifying a lease of real estate is usually straightforward – but some scenarios will require judgement.

1 Overview

A lease is a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration. (IFRS 16.B9)

The key factors to consider when applying the lease definition are as follows.

Landlord lease definition

2 Applying the definition to real estate

Types of properties common in real estate leases include:

  • land and buildings;
  • office space: e.g. a floor of a building;
  • retail space;
  • specified spots in a car park; and
  • residential property.

When applying the lease definition to real estate arrangements, it will usually be clear whether the arrangement meets the lease definition criteria.

Key factors to consider when applying the lease definition are as follows.

Key factor

Criteria usually met in real estate arrangements?

Specified asset

(IFRS 16.B13, IFRS 16.BC111)

Yes

Generally, the address or particular component of a property (e.g. numbered floors of a building or units in a shopping

Capacity portions

(IFRS 16.B20)

Yes

Generally, a tenant has exclusive use of the leased property, or a defined portion of that property that is physically distinct (e.g. a floor of a building). In practice, this would be specified in the agreement.

Substantive substitution rights

(IFRS 16.B14–B19, IFRS 16.BC112–BC115)

No

Generally, there are not substantive substitution rights because a tenant physically occupies the leased property and may have invested in leasehold improvements that are not easy to dismantle and reassemble elsewhere.

Tenant obtains substantially all of the economic benefits?

(IFRS 16.B21–B23)

Yes

If the tenant has exclusive use of the property. This can include directly using the property or subleasing it.

Tenant has the right to direct the use of the asset?

(IFRS 16.B24–B30)

Yes

Generally, the tenant has the right to direct the use of the underlying property. For example, the tenant of an office building will usually have control over who they grant access to, the hours of operation and activities performed on the property.

Although it is common for property leases to include conditions that define the scope of the tenant’s right to use the property (e.g. a requirement to follow a particular operating practice or only to use the property for the agreed purpose), these are usually the landlord’s protective rights and do not prevent the tenant from having the right to direct the use of the asset within that scope.

However, in some cases the nature of the property may need to be considered.

The ‘period of use’ (IFRS 16 Definition)is the total period of time that an asset is used to fulfil a contract with a lessee (including any non-consecutive periods of time). The page Lease term deals with determination of the lease term and landlord recognition of operating lease income when the period of use comprises non-consecutive periods.

Even if an asset is specified in a contract, a lessee does not control the use of an identified asset if the lessor has a substantive right to substitute the asset for an alternative asset throughout the period of use. (IFRS 16.B14–B15)

Food for thought – Why is lease identification important for landlords?

Lease identification is an important issue for landlords because it impacts presentation and disclosures, and a number of measurement issues.

A landlord continues to be required to assess whether each lease is an operating lease or a finance lease. Although many real estate leases will continue to be classified as operating leases, it is possible that some structured leases will be classified as finance leases – see Lease classification. In addition, IFRS 16 includes a new approach to the classification of sub-leases, which may result in more sub-leases being classified as finance leases – see Sale-and-leaseback.

A landlord is required to present and/or disclose operating lease income separately from other forms of income, including income that it earns by delivering services to tenants. This is discussed at more length in Separating components of a contract on components.

In addition, income recognition is governed by IFRS 16 (see Operating lease and Finance lease) and changes to the lease contract are accounted for in accordance with the specific guidance on lease modifications included in IFRS 16 (see Lease modifications).

Food for thought – Are there any recognition exemptions for lessors?

No. This is one of the differences between lessee and lessor accounting. (IFRS 16.5, IFRS 16.BC94)

A lessee can elect not to apply the lease accounting model to:

  • short-term leases: i.e. leases for which the lease term as determined under IFRS 16 is 12 months or less; and
  • leases in which the underlying asset is of low value.

However, neither of these exemptions is available to lessors.

Food for thought – What is the period of use if the landlord provides the right to use the property to the tenant for non-consecutive periods?

An arrangement to use an identified property would meet the definition of a lease if it contains intermittent periods during which the tenant does not have the right to control the use of the asset.

For example, Retailer V sells beachwear (swimwear, beach umbrellas, beach towels etc) and has the exclusive right to use a retail space for six months during spring and summer. The contract runs for 10 years. For the remaining six months of the year, the space is leased to a different retailer, which sells equipment for winter sports.

In this situation, the period of use is 60 months. This is because V can use the space for six months each year over the 10-year contract. The use of the same retail space by a different tenant in the remaining months of the year does not prevent the contract from being a lease (provided that the other aspects of the definition are met).

This means that companies cannot avoid lease accounting by including in the contract term periods during which the customer cannot make the decisions about how and for what purpose the asset is used and/or obtain substantially all of the economic benefits from use of the identified asset.

3 Typical real estate arrangements

The following cases show considerations for landlords when evaluating whether common real estate arrangements contain a lease.

Case – Lease of office space

Landlord W leases two floors of an office building to Tenant M.

Under the contract, M has exclusive use of the floors and can fit out the premises as long as it does not make any structural changes to the building and it returns the property to W in its original condition at the end of the lease.

M has full control over who can access the floors, the hours of operation and what business its staff performs on the site (within legal limits).

In this scenario, there is a lease. This is because:

  • the floors are explicitly specified in the contract and physically distinct from the rest of the building;
  • M obtains all of the economic benefits because it has exclusive use;
  • W does not have a substantive substitution right; and
  • M directs the use of the office space.

Case – Capacity portion is an identified asset

Supplier S enters into an arrangement with Customer C for the right to store its products in a specified storage warehouse. Within this storage warehouse, Rooms V, W and X are contractually allocated to C for its exclusive use. S has no substitution rights. Rooms V, W and X represent 60% of the warehouse’s total storage capacity.

Landlord lease definition

In this scenario, there is an identified asset even though C is using only 60% of the warehouse’s total storage capacity. This is because:

  • the rooms that comprise the 60% usage are explicitly specified in the contract;
  • the rooms are physically distinct from the other storage locations within the warehouse; and
  • S has no substitution rights.

To complete its assessment of whether there is a lease, S then considers whether C has the right to direct the use of Rooms V, W and X, noting that C has the right to obtain substantially all of the economic benefits from their use by virtue of its exclusive use rights.

Case – Capacity portion is not an identified asset

Landlord E leases one floor of an office building to Company D. In addition, D enters into an arrangement with E for the right to use the building’s car park, where individual spaces are unmarked and not assigned to specific tenants. As part of the arrangement, D’s staff can park a maximum of eight cars, anywhere in the car park, at any given time. The car park has a total of 40 spaces. E has similar arrangements in place with its other tenants in the building for the remaining car spaces.

Landlord lease definition

E applies the lease definition separately to the office space and the car park, because the assets are physically distinct and can be used by D independently of each other. E concludes that there is a lease of one floor of the office building.

However, in the case of the car park there is no identified asset. This is because D only has rights to 20% of the car park’s capacity and that capacity portion neither is physically distinct from the remainder of the car park nor represents substantially all of the capacity of the car park. Therefore, D does not have the right to substantially all of the benefits of the entire car park.

By contrast, if E provided D with the right to use eight car spaces in the building’s car park and the assigned spaces were clearly marked for D’s use, then there would be an identified asset. This is because in this situation D has the right to use a portion of the car park that is physically distinct.

To complete its assessment of whether there is a lease, E then considers whether D obtains substantially all of the economic benefits from the use of the eight car spaces, and who has the right to direct their use.

Case – Substitution right: Retail space

Company P owns a large shopping centre and enters into a contract with Customer M to lease a retail space for five years.

Under the contract, P can require M to relocate to another retail space within the shopping centre. P would need to pay the costs of relocation and provide M with another space of similar quality and size. P would only benefit economically from relocating M if a major new tenant were to move in, taking up a large amount of space at a sufficiently higher rate than the existing tenants.

In this case, P’s substitution right is not substantive. Although the circumstance may arise, an assessment of whether a supplier’s substitution right is substantive is made at inception of the contract based on the conditions at that time and does not include consideration of future events that are not likely to occur. (IFRS 16.B16)

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