This case study has been developed from a recent project. The details have been changed to protect client confidentiality.
Change Pty Ltd had been occupying 3 floors of a prime office block in Sydney CBD for 10 years, with 5 years left to run on their lease.
Their current space was greater than their requirement due to the configuration. There were many partitioned offices and a poor utilisation of space given their organisational structure.
Four options were presented to them;
Option 1> remain in their current space with the current configuration and in 2007 when the lease expired, the landlord would provide them with an incentive to stay and Change would fit out the space according to its requirements. Only a small amount of capital expenditure would be incurred immediately in order to suit short term requirements.
Option 2> rationalise their current space and sublease the floor they freed up in the rationalisation. This would require capital expenditure immediately on fit out for the retained space, with a new fit out in 2007 on renewal of the lease.
Option 3> relocate to a space the same size as the current space.
Option 4> relocate and consolidate into smaller area.
A study was undertaken which looked at the financial impacts of each option over a ten year period, including rental growth, incentives, the cost of each configuration and fit out and of any make good which would have been required if lease was terminated.
Apex then quantified any depreciation consequences of each option. Below is an outlined of these consequences.
Option 1> Analysis of immediate expenditure to identify revenue and capital expenditures. The existing tax depreciation schedules would then require updating to take into account additions and disposals. In 2007 it would be necessary to formulate the landlord's contribution so as to protect the ability of the tenant to incur capital expenditure on any assets and thus claim the depreciation. Again, the existing schedules would require updating to reflect additions and disposals.
Option 2> Existing tax depreciation schedules would require updating to take into account the immediate capital expenditure as well as identifying any write offs and revenue expenditure. As with Option 1, in 2007 it would be necessary to protect the ability of the tenant to incur capital expenditure on any assets and claim the depreciation. The existing schedules would also require updating to reflect additions and disposals.
Options 3 & 4> The consequences of leaving the current space must be identified. Is there a make good clause that requires the demolition of existing plant or tenant's improvements that the tenant is claiming depreciation for? If so, there may be substantial write offs available. If the tenant is intending on selling any assets either to the landlord or the incoming tenant, then balancing adjustments and capital gains tax calculations will be required. When negotiating the new lease, if possible the tenant should own and incur capital expenditure on as much plant as possible to protect depreciation deductions, although this needs to be analysed in conjunction with alternate incentives that may be on offer. Finally, depreciation schedules will be required for the new office space.
It was possible for Apex to estimate the depreciation available for each options with no more information than was generated for the original formulation of the four options. This enables the client to make an informed decision with as much detailed financial analysis that is available.