Appraisal Institute of Canada Annual ConferenceIFRS – Research and Learnings From Implementations Abroad

Friday, May 29, 2009 – 1:30 pm to 3:00 pm

IFRS Timetable2

Jan 1/09 Jan 1/10 Jan 1/11

Calendar year periods beginning

IFRSComparative

figures

TRANSITION to IFRS is approaching fast!

Disclosure ofplan for convergence,key elements & timing

12/31/08

IFRS Opening Balance Sheet

Disclosure ofprogress towards

plan and key GAAP differences

12/31/09

Q2/09

Disclosure ofquantitative

impact of IFRSand key policy choices

12/31/10

IFRSgo-live

Last Canadian

GAAP Reporting 12/31/10

We are here

Two Key IFRS’s Affecting Real Estate

• IAS 40 - Investment Properties– “Investment Properties” specifically defined

– Land and/or buildings

– Held to earn rental income or capital appreciation

– Excludes properties that earn “significant” ancillary services (e.g. owner-managed hotels, seniors housing)

– Includes properties under development

• IAS 16 – Property Plant & Equipment– Applies to “owner-occupied property”

– Property held for supply of services or for own administrative use

– Properties with significant ancillary services

4

IAS 40 Investment Properties – Two options

Fair Value Model• Initially measure at cost• Measure at fair value every

reporting period• Recognize changes in fair

value in Profit & Loss• No depreciation or

impairment losses

Cost Model• Initially measure at cost• Depreciate• Fair values of investment

properties must be reported in the Notes

• Impairment losses apply

• Accounting policy choice is applied to all investment properties• Once you choose Fair Value you cannot go back to Cost

5

IAS 40-Investment property – fair value measurement

• Fair value must be determined whether accounting policy choice is fair value model or cost model

• Fair value should be determined each reporting period

• An entity is not required to determine fair value on the basis of a valuation by an independent valuer– However the standard encourages it– Recommends that the valuer be:

• Independent• holds a recognized and relevant professional qualification• has recent experience in the location and category of property being

valued

6

IAS 40-Investment property – what is fair value?

• Definition

The price at which the property could be exchanged between knowledgeable, willing parties in an arm’s length transaction.

– Excludes special terms or circumstances associated with the property

• Fair value excludes costs to sell

• Fair value excludes transaction costs initially recognized

• Fair value must reflect market conditions at the balance sheet date

• Must not double-count assets or liabilities that are separately recognized as assets or liabilities

– E.g. straight-line rent receivable

• Exclude any future capital expenditures that will improve or enhance the property, nor future benefits from these expenditures

7

IAS 40-Investment property – what is fair value? – cont’d• Standard provide guidance regarding determining fair value:

– Current prices in an active market for similar property in same location, condition and similar lease contracts

– Discounted cash flow analysis based on reliable estimates of future cash flows

– If no active market exists:• Current prices in active market for properties of different nature,

condition, location or lease contracts, adjusted to reflect differences

• Recent prices of similar properties on less active markets, with adjustments to reflect changes in economic conditions

– Reflects rental income from current leases and reasonable assumptions about rental income from future leases

8

IAS 16 – Property Plant & Equipment(Properties – not meeting Investment Property definition)

Cost Model• Initially measure at cost• Depreciate• Impairment losses• Same as Canadian GAAP

Revaluation Model• Initially measure at cost• Measure at fair value

(annually)• Depreciation recognized

based on new fair value amount

• Fair value increases credited to Equity

• Fair value decreases in excess of equity credits recognized in Profit & Loss

Revaluation model policy choice is applied to a class of PP&E, not

all PP&E, and not individual items

IFRS – Fair Value and Independent Appraisals• IFRS does not require but encourages entities to use

independent appraisers to determine the fair value of investment property.

• IAS 40, paragraph 32 states:

“...An entity is encouraged, but not required, to determine the fair value of investment property on the basis of a valuation by an independent valuer who holds a recognised and relevant professional qualification and has recent experience in the location and category of the investment property being valued”

• The decision to use an independent appraiser has been driven by:– industry practice

– stakeholder requirements

– corporate governance (i.e. Audit Committees, Boards)

REALpac/McGill ResearchIssued February 2008

Convergence to IFRS Abroad – REALpac/McGill Research

• REALpac commissioned professors at McGill Desautels Faculty of Management to examine:– IFRS reporting practices of real estate entities abroad – Europe, U.K.,

Scandinavia, Australia and Asia– Accounting policy choices – investment property, PP&E– Fair value processes– Non-GAAP reporting

• Reporting year examined – 2005– First year of IFRS adoption for Europe and Australia

• 33 companies listed on the FTSE EPRA/NAREIT Global Real Estate Index– Market capitalization as at May 31, 2007 was €103.5B– Review of annual reports and other supplemental reports

33 companies reviewed – 16 countriesCompany Country

1. Aedes S.p.A. Italy

2. Babis Vovos Greece

3. Befimmo Belgium

4. Beni Stabili Italy

5. British Land U.K.

6. CapitaLand Singapore

7. Castellum Sweden

8. Citycon Finland

9. Confinimmo Belgium

10. Corio Netherlands

11. Deutsche Wohnen Germany

12. Gecina France

13. GPT Group Australia

14. Hammerson U.K.

15. Hang Lung Prop. Hong Kong

16. Hong Kong Land Hong Kong

17. Immobiliaria Colonial Spain

Company Country

18. Immofinanz Austria

19. Intervest Offices Belgium

20. IVG Immobilien Germany

21. Klepierre France

22. Land Securities U.K.

23. Liberty Int’l PLC U.K.

24. Metrovacesa Spain

25. Risanamento Italy

26. Rodamco Europe Netherlands

27. Sino Land Company Hong Kong

28. Sjaelso Gruppen Denmark

29. Sponda Finland

30. Unibail France

31. Wereldhave Netherlands

32. Westfield Group Australia

33. Wihlborgs Fastigheter Sweden

Investment Properties - FV or Cost?

Investment Properties – FV or Cost? Update

Use of External Appraisers

• 94% of companies used external appraisers to fair value investment properties

Number of External Appraisers Used

• It is not uncommon to use more that one appraiser

Fair Value Standards Used

Frequency of external valuation of portfolio

• Many firms did not specify the frequency of external appraisals• For those firms that did specify, the majority were completed

annually or more frequently

PP&E- Revaluation or Cost?

PP&E – Revaluation or Cost? Update

Best practice disclosures• Information provided by operating segment

– geographical or asset class

• Information by property – in some cases can be quite detailed and may include

– fair value– carrying value– cost– name of most recent independent valuator– date of last valuation– rental revenues and NOI– occupancy rates– cap rates or discount rates– valuation method used– major tenants

• Many annual reports include the external valuator’s report

McGill Desautel Faculty of Management - ContactsSteve Fortin, Associate Professor of Accounting

514-498-4021

steve.fortin@mcgill.ca

Desmond Tsang, Assistant Professor of Accounting

514-398-5417

desmond.tsang@mcgill.ca

Francois-Pierre Dionne

514-967-7228

francois-pierre.dionne@mail.mcgill.ca

1001, Sherbrooke Street West

Montreal, Quebec

Canada

H3A 1G5

Research – Harvard Business SchoolEdward Riedl, PhD, CPA, CMA, CIA

Associate Professor

Convergence to IFRS in the EU – Harvard Business School Research

• Professor Edward J. Riedl has completed a number of research papers dealing with:1. IFRS adoption by the EU – IAS 40 accounting policy choice

• 133 EU companies examined

2. Causes and implications of the accounting policy choice in IAS 40

3. IFRS adoption by the EU – use of external appraisers• 141 EU companies examined

4. UK research - use of external appraisers and implications to cost of capital

5. UK research - use of external appraisers and implications to audit fees

EU – IAS 40 Accounting Policy Choice Upon AdoptionModel Choice under IAS 40

Country Total Firms Cost Fair Value Pre-IFRS GAAP# % # % # % Cost Reval Treat as

Model Model PP&EAustria 8 6.0% 1 3.7% 7 6.6% X XBelgium 9 6.8% 0 0.0% 9 8.5% X X XDenmark 3 2.3% 0 0.0% 3 2.8% XFinland 4 3.0% 0 0.0% 4 3.8% XFrance 18 13.5% 9 33.3% 9 8.5% X XGermany 18 13.5% 10 37.0% 8 7.5% X XGreece 3 2.3% 0 0.0% 3 2.8% XItaly 4 3.0% 2 7.4% 2 1.9% XNetherlands 6 4.5% 1 3.7% 5 4.7% X XNorway 1 0.8% 0 0.0% 1 0.9% X XPoland 2 1.5% 0 0.0% 2 1.9% X X XSpain 5 3.8% 4 14.8% 1 0.9% X XSweden 9 6.8% 0 0.0% 9 8.5% X XSwitzerland 6 4.5% 0 0.0% 6 5.7% X X XUK 37 27.8% 0 0.0% 37 34.9% XTotal 133 100.0% 27 100.0% 106 100%

EU – IAS 40 Accounting Policy Choice – Causes underlying a company’s decision• Companies that chose the Fair Value option were more

likely to:– have reported under a pre-IFRS domestic GAAP that incorporated

elements of fair value reporting on the financial statements• Revaluation accounting

– have ownership that was more dispersed (i.e. Public entity with a wider group of unitholders/shareholders)

– demonstrate a greater commitment to reporting transparency• Use of external appraisers

• Early adoption of IFRS

EU – IAS 40 Accounting Policy Choice – Other observations

• There is evidence of opportunism by those firms choosing the fair value option– companies adopting the fair value option reported larger fair value

gains than the gains that would have been recognized by those companies choosing the Cost Model

• Limited evidence that firms choosing the fair value model have greater liquidity than those choosing the cost model– lower mean and median bid-ask spreads– fewer days with no trading of equity– higher daily trading volume– May suggest that market participants do not perceive, on average,

that disclosures of fair value is equivalent to the recognition of fair value on the primary financial statements

External Monitoring – EU Adoption of IFRS – Use of External Appraisers

# Using External Average % of PropertyCountry # Firms Appraiser for All Property Evaluated ExternallyAustria 8 8 100% 100%Belgium 10 9 90% 90%Denmark 3 0 0% 0%Finland 4 4 100% 100%France 18 15 83% 89%Germany 22 14 64% 64%Greece 3 1 33% 33%Italy 5 5 100% 100%Netherlands 6 5 83% 89%Norway 1 0 0% 50%Poland 2 1 50% 50%Spain 5 5 100% 100%Sweden 9 4 44% 58%Switzerland 6 5 83% 83%UK 39 34 87% 93%Total 141 110 78% 82%

External Appraisals and Cost of Capital – UK ResearchSample• Sample of 64 UK investment property firms, examining 255

firm-years between 1990-1999• UK domestic GAAP allowed revaluation accounting

Observations• Firms using external appraisers have a lower cost of capital

– observed lower bid-ask spreads– Market participants perceive information less reliable/relevant for those firms

employing internal appraisers – therefore risk premium assigned– Therefore there is a trade-off between lower cost of capital and higher

monitoring costs

• There was no favourable impact to cost of capital for firms employing a big-6 Audit firm versus those firms that did not

– Suggests auditors primarily attest to appraisers’ estimates as opposed to generating information

External Appraisals and Audit Fees – UK ResearchSample• Sample of 92 UK investment property firms, examining 574

firm-years between 1987-1999• UK domestic GAAP allowed revaluation accounting

Observations• Firms using external appraisers have lower audit fees

– Observed that firms employing internal appraisers had relatively higher statutory audit fees

– Suggests auditors attempt to mitigate the greater managerial influence over internal appraisers’ fair value estimates by undertaking additional effort

• Increased audit fees occurred whether the firm employed a Big 6 audit firm or not

– Auditor’s additional effort is economically significant

• The higher cost of employing external appraisers can be somewhat offset by lower audit fees

Harvard Business School – Referenced Research1. “Causes and Consequences of Choosing Historical Cost versus Fair Value”, March

2008

Karl A. Muller, III – Pennsylvania State University

Edward J. Riedl* – Harvard Business School

Thorsten Sellhorn – Ruhr-Universitӓt Bochum

2. “External Monitoring of Property Appraisal Estimates and Information Asymmetry”, Journal of Accounting Research Vol. 40 No. 3, June 2002

Karl A. Muller III and Edward J. Riedl*

3. “Managerial Influence Over Property Appraisers’ Estimates and Auditors’ Reliance on the Work of Experts”, October 2005

Karl A. Muller, III – Pennsylvania State University

Edward J. Riedl* – Harvard Business School

* Edward J. Riedl

Harvard Business School

Morgan Hall 365

Boston, MA 02163

617-495-6368

eriedl@hbs.edu

IFRS Markets - General Reporting Practices

European Public Real Estate Association (EPRA)• Industry body that represents public real estate/REITs in

Europe

• EPRA publishes a “Best Practices Recommendations” document for financial reporting.

• EPRA’s key recommendations around investment property are:1. Real estate companies should account for property investments

based upon the fair value model (IAS 40).

2. The valuation of investment property at fair value should be assessed in accordance with International Valuation Standards as set out by the IVSC.

3. Valuations should be performed by an external valuer at least once a year per the year end reporting date.

4. Companies are encouraged to have their property portfolios externally valued twice per year.

EPRA – Other Best Practice Reporting Recommendations• EPRA provides standard definitions and encourages

consistent and comparable reporting of the following key metrics:1. EPRA Earnings (a similar measure to FFO)

2. EPRA Net Asset Value

3. EPRA Triple net NAV

4. EPRA Net Initial Yield

5. Vacancy rate

6. Like for Like Net Rental Income

7. Other disclosures – leasing data, valuation data, rental data and development properties

Other IFRS Markets – Financial Reporting Practices• U.K.

– Generally follow EPRA’s best practice financial reporting recommendations.

– Virtually all U.K. REITs report investment properties at fair value.

– Virtually all U.K. REITs use independent valuers to fair value investment properties once per year, or more frequently.

– Most entities report NAV.

• Australia– Virtually all Australian Listed Property Trusts (LPTs) report

investment properties at fair value.

– Many large LPTs fair value their investment properties on a rotational basis, generally a portion of the portfolio every 3 years.

– Most entities report NAV.

– Most entities report an FFO-like number.

What can Canada Expect with IFRS Convergence?

Teresa’s Views1. Observation: Canada’s domestic GAAP is based on a

historical cost and depreciation model for investment properties (i.e. treated as PP&E)

Possible Outcome: – We will see more than an insignificant number of real estate entities that

will choose the cost option under IAS 40 upon initial adoption of IFRS– Over time (3-5 years), we will see those entities move to the fair value

option under IAS 40

Reasoning– Many entities have legacy debt agreements and trust indentures that are

based on historical cost accounting – i.e. Covenants based on “Book Value”. Entities need time to either allow these agreements to expire, be renegotiated or refinanced with newer agreements that are IFRS-friendly.

– Market leaders will set industry practice over time.

Teresa’s Views – cont’d2. Observation: The market rewards those entities that

provide information that is deemed more transparent and less biased – i.e. use of independent valuers to determine fair value of investment properties

Possible Outcome: – The majority of real estate entities will choose to engage independent

appraisers to fair value investment properties for the first few years of IFRS reporting

– Over time (3-5 years), we will see the more sophisticated entities move a greater share of valuation work internally.

Reasoning– Most entities don’t have the in-house expertise today.– Preparing for the first reporting of IFRS is a huge undertaking and can only

be accomplished with the assistance of external appraisers.– The market demands transparency but at the same time rewards cost

efficiency.– Canadian Pension Plans will influence acceptable industry practice.

Teresa’s Views – cont’d3. Observation: Canada is not Europe and not Australia.

Canada operates under a stricter regulatory environment than the EU or Australia – i.e. CEO/CFO certification required.

Possible Outcome: – Increased reliance on independent appraisals to meet corporate

governance requirements.– Audit firms will be directly or indirectly demanding increased use of

external, independent appraisers.

Reasoning– Audit fees should be higher where entities choose internal valuations

(some have an opposing view).– Market participants will demand independent valuation of investment

properties.

Teresa’s Views – cont’d4. Observation: The real estate industry will demand the

development of best practice financial reporting and processes under IFRS.

Possible Outcome: – REALpac will be involved in setting best practice financial reporting

recommendations for:• FFO-like metric

• NAV

• Yields

• IAS 40 accounting policy choice

• External valuation processes and standards

• Disclosures

Reasoning– There will likely be some inconsistencies in how entities will report under

IFRS the first few years following IFRS adoption.– Market participants and real estate entities will seek more transparent and

consistent reporting within the industry.

Teresa’s Views – cont’d5. Observation: IFRS convergence has been called the

“Accountants’ Y2K”

Possible Outcome: – There is much hype around IFRS convergence but in the end the transition

to IFRS will be generally smooth for most Canadian public REITs/REOCs.– Analysts, investors and other stakeholders will be well prepared for the

change in financial reporting.

Reasoning– IFRS Convergence is just another project. CFOs have proven capable of

meeting financial reporting challenges in the past – e.g. SOX– Canada had 5 years to prepare for convergence (versus 2 in Europe and

Australia).– In real estate, FFO, AFFO, and cash flows are the important income

statement metrics. Analysts and investors will learn to look through the financial statement “noise”.

– Canada will “get it right” for the North American experiment.

Q&A

DisclaimerThe information that may be contained herein has been compiled by REALpac from sources believed to be reliable, but no representation or warranty, express or implied, is made by REALpac, its directors, officers and staff or any other person as to its accuracy, completeness or correctness. Opinions, estimates, conclusions, or other information expressed or contained herein constitute REALpac's judgment as of the publication date, are subject to change without notice and are provided in good faith but without representation or warranty as aforesaid.

 

REALpac and its directors, officers, and staff, assume no liability for damage or loss arising from the use of information contained herein. REALpac is not providing investment, legal or tax advice. Readers are urged to consult their own professional advisors for further confirmation and further information.