Property valuations under IFRS 13

How does IFRS 13 define fair value for property?

Fair value is the price that would be received to sell the property in an orderly transaction between market participants at the measurement date. It is a market view, not the owner's: synergies only the current owner enjoys are ignored, and so are its plans unless market participants would share them. Transaction costs are not deducted, although in markets where valuers quote values net of a buyer's transfer taxes, that net figure reflects the price the seller would receive.

Which valuation methods are used?

• Income capitalisation: net rent, or the estimated rental value for a reversion, divided by a market yield. Common for let offices, shops and warehouses.
• Discounted cash flow: forecast rents, voids, incentives and costs over ten years or so, plus an exit value, discounted at a market rate. Common for complex or multi-let assets and in many markets outside the UK.
• Comparable sales: prices of similar properties sold recently, adjusted for differences. Common for residential units and land.
• Residual method: for development sites and property under construction, the completed value less costs to complete, finance and a developer's profit.

Property valuations: an office valued on a yield

A let office produces net rent of CU 5.0 million a year. Comparable transactions suggest a yield of 6.00% for a building of this quality, location and lease length. The valuation is 5.0 / 6.00% = 83.3 million.

A quarter-point change in the yield moves the value by around 4%, more than half a year's rent, all through profit or loss under the fair value model. The effect is not symmetrical: a fall in yield adds more than the same rise takes away. This is why yield sensitivity is the disclosure investors read first.

Why are most property valuations Level 3?

A level is assigned according to the lowest-level input that is significant to the whole measurement. Even when comparable transactions exist, the valuer adjusts them for the property's location, condition, tenants and lease terms, and the estimated rental value and yield it settles on are judgements, not quoted prices. Those are significant unobservable inputs, so the valuation is Level 3. Standard residential flats in an active market, valued directly from recent sales of near-identical units, can sometimes be Level 2.

What is highest and best use?

A property is valued on the use that market participants would make of it that is physically possible, legally permissible and financially feasible, even if the owner uses it differently. An office in an area recently rezoned for housing may be worth more as a residential conversion site; if so, that is its fair value. When highest and best use differs from current use, the company discloses that fact and why it uses the property as it does.

Who values the property?

IAS 40 encourages, but does not require, valuation by an independent valuer with a recognised qualification and recent experience in the location and type of property, and requires disclosure of the extent to which valuations were done by such a valuer. Most listed property companies use external valuers working to international valuation standards, such as the RICS Red Book. Management remains responsible: it should check the data given to the valuer, challenge key assumptions and explain significant movements.

What adjustments link the valuation to the balance sheet?

The valuation already reflects the leases, so separately recognised accrued rent and lease incentive assets are deducted to avoid double counting. For a leasehold property, where the valuation is net of the ground rent payable, the recognised lease liability is added back to arrive at the fair value of the right-of-use asset. See straight-line rental income and lease incentives for landlords.

What must be disclosed?

For Level 3 valuations, IFRS 13 requires the valuation techniques used, quantitative information about significant unobservable inputs, usually ranges and weighted averages of rental values and yields by property type, a narrative description of how changes in those inputs would change the value, a reconciliation from opening to closing balances, and a description of the valuation process. Many companies go further and give a numeric sensitivity, such as the effect of a quarter-point change in yields. See the fair value hierarchy.

How does US GAAP compare?

ASC 820 defines fair value in the same way, but outside investment companies US GAAP holds real estate at depreciated cost, so fair value of property is mainly used for impairment and disclosure. See investment property: fair value or cost and real estate accounting.

This guide is general information. It is not tax or legal advice for your situation.