Fair value is determined under IFRS 13. Fair value is “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”.

Fair value reflects rental income from current leases and other assumptions that market participants would make about future rental income, based on current conditions. Current rental agreements might provide for increases at five-year intervals based on inflation plus a set percentage. It is reasonable to estimate future rentals based on official projected inflation rates.

There is a rebuttable presumption that fair value can be measured reliably continuously. Excluded from the fair value measurement requirement are:

• investment properties under construction for which the fair value cannot be reliably measured at present, but for which the entity expects the fair value to be reliably measured at a later date during the construction or when the construction is completed; and
• investment properties for which, in exceptional cases and on initial recognition only, the fair value cannot be measured reliably continuingly.

Fair value is not readily measurable Entity A is a real estate developer and is constructing an investment property. The entity was holding a piece of land for its capital appreciation and has subsequently started construction of a building for the purpose of earning rentals. Due to significant uncertainty as to future cash inflows, the entity is not able to determine the fair value of the building reliably. However, the fair value of the land can be determined based on observable prices. Entity A applies the fair value model to its investment properties. The entity has a policy choice of accounting for the land and the building either as two separate units of account or as a single unit of account. Depending on the policy choice made, the entity either: ·        accounts for the land at fair value and for the building at cost until the fair value of the building becomes reliably determinable; or ·        accounts for both the land and the building at cost until the fair value of the investment property as a whole can be determined reliably.

Once an entity becomes able to reliably measure the fair value of an investment property under construction, or the construction is completed, it measures that property at its fair value. The property is measured using the cost model under IAS 16 until that point.

Subsequent remeasurement of a leased asset from the amount initially recognised (cost) to fair value should not result in an initial gain or loss. The fair value on the acquisition, net of the expected lease liabilities, is normally nil. However, where remeasurement to fair value takes place at different times, a gain or loss could arise. After initial recognition, the basis for determining fair value would take into account other factors besides the lease payments and the discount rate. This could arise when an election to use the fair value model is made after initial recognition.

The fair value of the investment property cannot be measured reliably continuingly when, and only when, the market for comparable property transactions is inactive and alternative reliable measures of fair value (for example, based on discounted cash flow projections) are not available. The market is deemed to be inactive when, for example, there are no recent transactions or available prices, or when judgment indicates that, in a market transaction, the seller was forced to sell a property at a below-market amount.

The range of reasonable measures of fair value for a property might be so great, in exceptional circumstances, that the choice of any single measure of fair value from the range would not be useful. Fair value might not be capable of being reliably measured continuingly. The cost model is adopted in these circumstances.

Where an entity has previously measured investment property at fair value, it must continue to do so even if comparable market transactions become less frequent or market prices become less readily available.

Subsequent remeasurement of a leased asset from the amount initially recognised (cost) to fair value should not result in an initial gain or loss. The fair value on the acquisition, net of the expected lease liabilities, is normally nil. However, where remeasurement to fair value takes place at different times, a gain or loss could arise. After initial recognition, the basis for determining fair value would take into account other factors besides the lease payments and the discount rate. This could arise when an election to use the fair value model is made after initial recognition.

The furniture is normally included in the fair value if an office is leased on a fully furnished basis. The furniture that is included in the fair value of the investment property would not be separately depreciated. The adjustments to the fair value of the whole property at each valuation date would take account of the condition of the furniture. If the furniture is recognised separately on the balance sheet, it is not included in the fair value of the property and it is depreciated over its useful life.

Prepaid or accrued operating lease income is excluded from the fair value of the related investment property. The prepaid or accrued operating lease income is a separate asset or liability.

Incentives paid by a lessor to a lessee to enter into a lease are initially recognised as an asset and treated as a reduction of the lease payments over the lease term. The fair value of the property is based on the net rentals (after deducting the incentive). The fair value does not reflect the element of the gross rental that has effectively been subsidised by the lessor through giving the incentive.

Lease incentives A lessor gives a cash incentive to a lessee of an investment property. The value of the incentive is C100,000. This is treated by the lessor as a reduction of lease payments and initially recorded as an asset. The property is valued at C10m, but this valuation incorporates the gross rentals that will be paid by the lessee. To avoid double-counting by the lessor, it is necessary to adjust the valuation downwards, to take account of the fact that the actual return to the lessor will be lower because the lessor has paid an incentive (and recorded it separately as an asset).

The fair value of a property held under a lease will reflect expected cash outflows as well as expected cash inflows. The former might include contingent rents payable as well as fixed lease payments. It will be necessary to add back the lease liability to the valuation amount to arrive at the fair value of the property. The lease liability is recorded as a liability on the balance sheet. Effectively, this is a ‘gross-up’ of the asset and the lease liability.

An entity might consider that the present value of future payments relating to an investment property will exceed its current estimate of the present value of future cash receipts. A frequently asked question might be where an entity has leased property, and the present value of future payments under that lease and other payments required exceeds what the entity can reasonably expect to earn from future rental income and other proceeds in present value terms. The entity will need to account first for the lease liability. Then the entity will need to review the shortfall. If the shortfall is less than the carrying amount of the asset, the asset is written down. If, in exceptional cases, the shortfall exceeds the carrying value, the asset is written down to nil. The entity then applies IAS 37 to record a provision for an onerous contract. The amount of the provision is also measured by reference to IAS 37.

Remeasurement of investment property: transaction costs incurred on acquisition – example Entity A acquires an investment property (in an orderly transaction with a third-party market participant) immediately before the end of its reporting period for CU100 million. It incurs additional costs in the form of legal and other professional fees of CU2 million at the time of initial recognition which are directly attributable to the acquisition of the property. These transaction costs are included in the initial measurement of the investment property in accordance with IAS 40. Therefore, the investment property is initially recognised at CU102 million. Entity A measures its investment property using IAS 40’s fair value model. At the end of the reporting period, the fair value of the investment property is unchanged from the price paid by Entity A of CU100 million. Under IFRS 13, the fair value of the investment property should be measured at the reporting date at the amount that would be received at that date from the sale of the property in an orderly transaction in Entity A’s principal (or most advantageous) market. If the property were to be sold, costs might be incurred by Entity A (as the seller) or by the purchaser as part of the transaction. However, under IFRS 13, transaction costs that would be incurred by Entity A if the property were sold should not be deducted from the fair value of the property. Likewise, costs that would be incurred by a purchaser (e.g. those similar to the legal and other professional fees capitalised by Entity A) would not be received by Entity A on sale of the investment property and, consequently, do not affect the investment property’s fair value as defined by IFRS 13. Accordingly, the property should be measured at the reporting date at CU100 million. The difference between this amount and the carrying amount of CU102 million should be recognised as a fair value adjustment in profit or loss in accordance with IAS 40. This example demonstrates that when an investment property is acquired immediately before the end of a reporting period, such that its fair value is unlikely to change between the date of acquisition and the end of the accounting period, it is likely that a downward revaluation will be recognised in profit or loss that is equal and opposite to the capitalised acquisition costs, if any.

Use of independent valuers

Entities are encouraged (but not required) to use, as the basis for measuring fair value, 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 Board decided that an independent valuation should not be required under IAS 40 because of the following considerations:

• the cost-benefit ratio of an independent valuation may be inappropriate for some entities; and
• independent valuers with appropriate expertise are not available in some markets.

Inability to measure fair value reliably

There is a rebuttable presumption that the fair value of an investment property can be measured reliably continuingly. But in exceptional cases, when an investment property is first acquired (or when an existing property first becomes an investment property after a change of use), there may be clear evidence that the fair value of the property is not reliably measurable continuingly. This arises when, and only when, the market for comparable properties is inactive (e.g. there are few recent transactions, price quotations are not current or observed transaction prices indicate that the seller was forced to sell) and alternative reliable measurements of fair value (e.g. based on discounted cash flows) are not available.

Note that the exception under IAS 40 is available only when the investment property is first recognised as such. If an investment property has previously been measured at fair value, it should continue to be measured at fair value until disposal (or until it otherwise ceases to be an investment property, for example because it becomes owner-occupied) even if comparable market transactions become less frequent or market prices become less readily available.

When, in the circumstances described above, it is not possible for an entity that uses the fair value model to measure the fair value of a particular property (other than an investment property under construction) reliably on initial recognition, that investment property is measured as follows:

• for owned investment property, using the cost model in IAS 16; and
• for investment property held by a lessee as a right-of-use asset, by IFRS 16.

In accounting for the property under IAS 16 or IFRS 16, the entity is required to assume that the residual value of the property is zero. The entity continues to apply IAS 16 or IFRS 16 until the disposal of the property. [IAS 40:53] Special rules apply for investment properties under construction.

When an entity is compelled, for the reasons set out in IAS 40:53, to measure a particular investment property using the cost model under IAS 16 or IFRS 16, it continues to measure all of its other investment property at fair value.

The circumstances described in IAS 40 are also relevant to determining the circumstances in which an entity using the cost model would be exempt from disclosing the fair value of investment property.

An economic downturn may increase the volatility of prices in real estate markets and restrict the level of comparator transactions against which to assess value. This may increase uncertainty around reported investment property fair value compared to ‘normal’ market conditions. For this reason, third-party valuers may include valuation uncertainty paragraphs in their reports to draw the reader’s attention to the financial backdrop against which the valuations have been assessed. Generally, this type of uncertainty paragraph may not caveat the valuation opinion provided, but it may make reference to major upheaval in the financial sector, reduced liquidity in the marketplace, restricted availability of debt and similar factors, and may state that these factors have caused increased uncertainty in respect of current real estate prices.

There is a rebuttable presumption in IAS 40 that the fair value of an investment property can be determined reliably continuingly; there is no exemption in a period of significant valuation uncertainty, even if comparable market transactions become less frequent or market prices become less readily available. It is only in exceptional cases when there is clear evidence when the entity first acquires an investment property (or when an existing property first becomes an investment property after an evidenced change in use) that fair value is not reliably determinable, that the entity is permitted to measure that investment property at cost while measuring its other investment properties at fair value. These exceptional cases are expected to be very rare.

Investment property in the course of construction

If an entity determines that the fair value of an investment property under construction is not reliably measurable but expects the fair value to be reliably measurable when construction is complete, the entity measures the investment property under construction at cost until the earlier of the fair value becoming reliably measurable or the completion of construction.

Once the entity can measure reliably the fair value of the investment property under construction, that property should be measured at fair value. Once construction is complete, it is presumed that fair value can be measured reliably. If this is not the case, following completion, the property is accounted for using the cost model by IAS 16 (for owned assets) or IFRS 16 (for investment property held by a lessee as a right-of-use asset), under the general requirements of IAS 40.

The presumption that the fair value of investment property under construction can be measured reliably can be rebutted only on initial recognition. An entity that has measured such property at fair value may not conclude that the fair value of the completed investment property cannot be determined reliably.

Changes in fair value

Changes in the fair value of investment property are recognised in profit or loss in the period in which they arise.

The fair value of investment property held under a lease

When a lessee uses the fair value model to measure an investment property that is held as a right-of-use asset, it is required to measure the right-of-use asset (rather than the underlying property) at fair value.

IFRS 16 specifies the basis for initial recognition of the cost of an investment property held by a lessee as a right-of-use asset. IAS 40 and IFRS 16 require investment property held by a lessee as a right-of-use asset to be remeasured, if necessary, to fair value if the entity chooses the fair value model. When lease payments are at market rates, the fair value of an investment property held by a lessee as a right-of-use asset at acquisition, net of all expected lease payments (including those relating to recognised lease liabilities), should be zero. Accordingly, remeasuring a right-of-use asset from cost by IFRS 16 to fair value by IAS 40 (taking into account the requirements in IAS 40) should not give rise to any initial gain or loss, unless the fair value is measured at different times. This could occur when an election to apply the fair value model is made after initial recognition.

Fair value of investment property held under a lease The requirements in IAS 40 are intended to specify that the fair value of a right-of-use asset to which the fair value model of IAS 40 is applied should be determined in the context of the lease contract from which the asset arises. This means that when the fair value model is applied, the carrying amount of a right-of-use asset is the fair value of the lease contract grossed up by the amount of the recognised lease liability (measured applying IFRS 16). This can be measured as: the present value of the expected rentals that could be received from a third-party sub-lease of the property (at market rates, at the measurement date); less the present value of all rentals (fixed and all variable) expected to be paid under the head lease; plus the recognised head lease liability measured in accordance with IFRS 16. Applying these requirements, if the lease payments are at market rates, the remeasurement of a right-of-use asset from cost in accordance with IFRS 16 to fair value in accordance with IAS 40 should not give rise to any initial gain or loss, unless the fair value is measured at different times. For example, consider a five-year lease contract which includes fixed annual payments of CU100 and expected annual variable payments based on usage of CU30. Ignoring the effect of discounting, the right-of-use asset and the lease liability recognised on the commencement date are both CU500 (i.e. the present value of the fixed lease payments). Assuming that at the commencement date the lease contract reflects market rate, on that date the carrying amount of the right-of-use asset applying the fair value model may be measured as: the presented value of the expected cash inflows of CU650; less the expected cash outflows of CU650; plus the recognised lease liability of CU500. Hence, the carrying amount of the right-of-use asset under the fair value model is CU500 and is equal to the carrying amount of the right-of-use asset determined under IFRS 16 at the commencement date – i.e. consistent with IAS 40:41, there is no initial gain or loss on remeasurement of the right-of-use asset from cost under IFRS 16 to fair value under IAS 40.

Anticipated liabilities

When an entity expects that the present value of its payments relating to an investment property (excluding payments relating to recognised liabilities) will exceed the present value of the related cash receipts, IAS 37 should be applied to determine whether a liability should be recognised and, if so, how that liability should be measured.