Lease agreements are explicitly listed as contract-based intangible assets under IFRS 3, but the circumstances under which they create separately recognisable intangible value are narrower than many assume. The introduction of IFRS 16 (Leases) in 2019 changed the interaction significantly — most leases are now recognised on the balance sheet as right-of-use assets and lease liabilities, reducing the scope for separate intangible recognition.
The intangible value in a lease arises specifically when the lease terms are favourable — when the lessee pays below the current market rent. In such cases, the below-market element represents a contract-based intangible asset that provides economic benefit to the acquirer beyond what a new lease at market rates would deliver.
Before IFRS 16, operating leases were entirely off-balance-sheet. A favourable operating lease acquired in a business combination was recognised as a separate intangible asset at the present value of the below-market rental savings.
After IFRS 16, most leases are recognised as right-of-use assets. In a business combination, IFRS 3 requires the acquirer to measure the acquired lease at the present value of the remaining lease payments, compared to market terms. The practical effect:
| Scenario | Treatment |
|---|---|
| Lease at market terms | Right-of-use asset and lease liability at IFRS 16 amounts; no separate intangible |
| Lease below market (favourable) | Right-of-use asset adjusted upward for the favourable terms, or separate intangible asset recognised |
| Lease above market (unfavourable) | Right-of-use asset adjusted downward, or separate liability recognised |
Under the current standards, lease intangible value exists only to the extent that the lease terms are favourable relative to current market rates. An at-market lease has no incremental intangible value because the right-of-use asset and lease liability are equivalent.
The valuation of a favourable lease is straightforward in concept:
Fair value = Present value of (Market rent - Contractual rent) x Remaining lease term
A lease may be below market for several reasons:
Obtain comparable rental evidence for equivalent properties in the same location, grade, and condition. Commercial property agents' market reports and recent transactions provide the best evidence.
Compare the contractual rent (including all service charges and additional costs) with the market rent. The difference is the annual favourable term benefit.
This includes the remaining lease term plus any renewal options that the lessee is reasonably expected to exercise at favourable rates.
Apply a discount rate appropriate for the certainty of the rental saving. Contracted terms with creditworthy landlords warrant relatively low risk premiums.
A retail chain is acquired with a flagship store lease in central London. The lease has 12 years remaining at £800,000 per annum. Current market rent for equivalent space is £1.2 million per annum. The annual favourable term is £400,000. At a 7% discount rate, the present value of the favourable lease is approximately £3.2 million — recognised as an intangible asset (or adjustment to the right-of-use asset) in the PPA.
The below-market analysis extends beyond base rent to all economic terms of the lease:
| Provision | Favourable If... |
|---|---|
| Base rent | Below current market rent |
| Rent escalation | Fixed escalation below market growth |
| Break clauses | Lessee has break rights providing flexibility |
| Assignment rights | Lessee can freely assign or sublet |
| Repair obligations | Landlord bears more obligations than market standard |
| Insurance costs | Below-market insurance provisions |
| Renewal terms | Pre-agreed renewal rates below expected future market |
Unfavourable lease terms — above-market rent, onerous repair obligations, or restrictive assignment provisions — represent a liability, not an asset. Under IFRS 3, unfavourable contracts assumed in a business combination must be recognised as liabilities at fair value. A comprehensive lease analysis must consider both favourable and unfavourable elements.
The useful life of a favourable lease intangible is the remaining period of favourable terms — the lesser of the remaining lease term (including probable renewals at favourable rates) and the period over which the terms remain below market.
Amortisation is typically straight-line over this period, though an accelerated pattern may be appropriate if the gap between contractual and market rates is expected to narrow as the lease approaches renewal.
In retail, hospitality, and food service acquisitions, lease portfolios can represent a significant proportion of intangible value — or a significant liability. A restaurant chain with 50 locations, each with a different lease profile, requires location-by-location analysis. Favourable leases in prime locations may be the primary source of value beyond goodwill. Unfavourable leases may be the primary source of risk.
For founders and business owners approaching a sale, lease portfolio management is a value driver:
Lease agreements are one of eight contract-based intangible assets under IFRS 3. For the complete taxonomy, see 35 types of intangible assets. To understand how property and intangible assets intersect, read bricks to bytes: valuing intangible assets.
Tony Hillier is an Advisor at Opagio with over 30 years of experience in structured finance, M&A advisory, and intangible asset valuation. Meet the team.
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