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Leases of land and buildings

Consider the following scenarios:

• Company A leases a building (and the underlying land) for 10 years. The remaining economic life of the building when the lease is entered into is 30 years. The lease is for considerably less than the economic life of the building so it is clear that both the land and buildings elements are operating leases and no separation is necessary.
• Company B takes on a 30-year lease of a new building and the underlying land. It is on a retail park and almost all of the value is ascribed to the building as land values are low. Although the building has a fabric life of 60 years, its economic life is estimated to be 30 years, after which it is expected to be technologically obsolete. The lease is for most of the economic life of the buildings and the present value of the minimum lease payments amounts to substantially all of the fair value of the building. It is not legally possible to lease the building without leasing the underlying land or, therefore, to estimate the relative fair values reliably. In any event, the lessor retains the residual value in the land and the lessee’s interest in the land alone must be insignificant. The entire lease is accounted for as a finance lease with an economic life of 30 years.
• Company C takes out a 25 year non-cancellable lease of premises in the centre of a major town where land values are high. There are upward-only rent reviews every 5 years. It is a modern building that may have a remaining economic life of 35 years (or perhaps more, as the building has a fabric life of 60 years) and the land is clearly valuable to the lessor, who will want a reasonable return from it over the lease term. In this case the interest in the building may or may not be a finance lease and the lessee’s leasehold interest in the land is not insignificant. Company C will have to undertake a valuation exercise to determine the allocation of minimum lease payments between the land and building elements of the lease in order to determine whether or not it has finance or operating leases over the land and buildings.