Fair Value Accounting for Investment Properties

by George Yungmann and David Taube

The International Accounting Standards Committee (IASC) recently issued an Exposure Draft (ED) which proposes that "investment property" be carried at fair value on a company's balance sheet. In addition, the ED recommends that increases and decreases in these fair values be reported in net income and that the properties not be depreciated. The proposed standard does not require the use of outside appraisals. Under the proposal, property would be defined as investment property if it meets the following conditions:

• it is held to earn rentals and/or for capital appreciation, and
• when the enterprise acquired the property, it expected that it would be able to determine the fair value of the property reliably at all times.

The ED includes a rebuttable presumption that an enterprise will be able to determine reliably the fair value of investment properties.

The IASC is a private sector body working to achieve uniform accounting standards around the world. Its members represent over 100 countries including the United States. Although not all of these countries accept the use of IASC standards, many either require or allow the use of them-especially by multi-national companies. The Financial Accounting Standards Board (FASB) has indicated that it intends to cooperate with other standard setting bodies to resolve specific issues and reduce differences in accounting standards between nations. IASC standards are not allowed to be used as U.S. Generally Accepted Accounting Principles (GAAP) but will certainly influence future FASB Standards.

Reporting Investment Properties at their Fair Value
Over the past 20 years, a number of real estate companies have publicly reported the fair value of their property portfolio. These presentations supplemented historical cost information required by GAAP. This information was presented either in "letters to shareholders," management's discussion and analysis, or in fair value financial statements. A number of these presentations were covered by audit opinions and were included in Securities and Exchange Commission filings. For over a decade, financial statement users clearly utilized this fair value information in evaluating the investment quality and financial strength of these companies.

More recently, equity valuations have been based primarily on multiples of operating measures such as Funds From Operations (FFO) and adjusted FFO, while a company's valuation of its portfolio has apparently become less relevant to financial statement users. In addition, some financial statement users question the reliability of the fair value estimates. Although fair value information continues to be published on a limited basis by some companies, these disclosures have become less extensive.

Potential Impact
There is no expectation that this international accounting standard will apply to REITs and other publicly traded real estate companies in the U.S. in the near term. However, some believe that this and other movements toward fair value accounting may provide the basis for gaining acceptance of a more appropriate method for depreciating investment properties. NAREIT will consider these developments as it continues its efforts to enhance the quality and relevance of the industry's financial reporting.

George Yungmann is Senior Advisor, Financial Standards, and David Taube is Financial Standards Analyst for NAREIT.

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