European developers face up to new valuation rules

Falling property values across Europe add complexity to a new requirement under international accounting rules for developers to value investment properties under construction at fair value rather than on a cost basis. ‘It is difficult enough assessing existing properties in the current climate where there is little transaction activity. It becomes more challenging when properties are still under construction,’ said Dermot Charleson, head of European valuations at Jones Lang LaSalle.

Charleson was commenting to PropertyEU after the International Valuation Standards Council (IVSC) announced it is to issue a discussion document with a draft guidance in the second quarter of 2009. To bridge the gap in the meantime the council has issued an Interim Position Statement, which it says summarises major valuation issues and provides its preliminary view of the valuation principles that should be adopted. The decision to draw up the guidance follows a change made by the International Accounting Standards Board (IASB), which brought investment property under construction into the scope of IAS 40 Investment Property from 1 January 2009.

The changes to IAS 40 mean that any entities who measure their completed investment property at fair value will also need to measure any investment property that is under construction on the date of the financial statement at fair value, subject only to the value being reliably determinable. Even if an entity measured its investment property using the cost model (the other measurement option available in IAS 40) it would still need to provide a fair value estimate of the partially completed property, since IAS 40 requires the disclosure of the fair value of investment property when the cost model for accounting is applied.

Charleson noted that listed developers in the UK such as British Land, Land Securities and Hammerson have been using this method for some years . But until now those in the rest of Europe generally used a cost-based method. He said the change has most relevance to listed European players, particularly those with more complex development projects.

Charleson said JLL has carried out pilot studies for some large players in Europe as this is unfamiliar territory for them. The work shows that some may have to take impairments on money already spent on developments. ‘In a strong investment market costs expended should be significantly below the realisable worth of the development. This will not necessarily be the case in the next few years,’ he said. Declining real estate values is a problem across the board, but Continental Europe is probably six to nine months behind the UK, where values are expected to fall 50% from peak to trough. Europe should not suffer as much as it is coming from a lower base.

Charleson expects the implementation of the new directive to be a challenge to some investors initially. Large listed companies developing around Europe need to have their ducks in line in order to implement the change, he said. Most listed companies now do six-monthly valuations and will next value in June. 'It is unfortunate timing to be switching the basis of reporting in this way because of the recent market declines and current uncertainty,' said Charleson, adding he believes we are now seeing a bedding down process. ‘Once companies incorporate the new approach that is what they will do.’ He said one potential loophole is the reliability issue. Whilst the guidance has not yet been finalised it is intended that companies will have an option to report on a cost basis if they can convince their accountants that fair value cannot be reliably determined.