Following on from our article
on Real Estate Cost Accounting in November 2018, we now discuss the threats companies face if property they own is inadequately tested for impairment. Impairment can affect all asset classes but, for the purposes of this exercise, we refer specifically to real estate.
Impairment of property occurs when its Fair Value (Market Value) is deemed to be less than its Book Value. Interestingly, this is the only scenario in which impairment technically exists. Where a property’s Fair Value is higher than its Book Value, no impairment is recorded. Nevertheless, both scenarios lead to incorrect reporting of values, misleading stakeholders and shareholders alike. There are risks for a company either if properties are impaired or undervalued on the balance sheet.
Most companies that own the property they operate from (owner-occupiers) typically account for their real estate assets at cost. They are therefore required, under IFRS, to perform impairment testing when ‘indications of impairment’ are shown. This is a vague term which does not enforce any specific frequency of assessment. As a result, assessment of property impairment tends to take place at significant trigger events rather than on a regular basis.
Assessment of potential for impairment
Real estate markets are volatile in nature and can be affected by both external and internal factors. This means that properties can become impaired for many reasons and this effect is often exaggerated in periods of economic downturn. Whilst internal changes to property like physical damage or the discontinuation of a plant may be obvious to owner-occupiers, important external factors are often ignored due to a lack of property market specific knowledge.
External factors could include fluctuations in the property market and changes to local planning regulation. If the impairment ‘assessor’ is not adequately informed about the property or the relevant market, they are likely to miss impairment indicators meaning that the process of assessing for impairment is fundamentally flawed. This could leave a company at risk of long-term, compounded impairment resulting in a misrepresentation of value to shareholders.
Clearly, this initial assessment should be supported by external advisors who have a working knowledge of the asset class and market fundamentals. Regulation also dictates that where a single asset is impaired, all assets in that class must be tested for impairment. At a time when financial reporting is under scrutiny, a lack of due diligence into an asset’s potential impairment will at best be viewed as irresponsible, but could have more serious implications for a company.
Often when a company’s core business function is removed from real estate, physical asset value is rarely considered and impairment testing becomes an
afterthought. Unfortunately, if impairment is assessed too late it can lead to problems. An obvious example is when a company fails to achieve the anticipated sale price on disposal of a property. Events like this can trigger uncertainty across a wider property portfolio and lead to large scale impairment testing. On the other hand, where assets are undervalued on a company’s balance sheet, the risks of a hostile takeover bid are increased. This could be easily avoided through having a programme of regular valuations in place.
Our final article in this series will outline the best practice for corporate’s property valuation strategy. We will draw on specific examples showing how an increasing number of corporates are implementing regular valuation programmes and reveal the benefits that this can have on wider corporate real estate strategy.
CORPORATE VALUATION SERVICES
The CBRE Corporate Valuation Services team specialise in the valuation of real estate assets for corporate clients and are the only dedicated valuation team specialising solely in the valuation of real estate assets for corporate occupiers.
The team cover the UK and EMEA, as well as the Americas and Asia Pacific regions working closely with our joined-up network of local valuers to ensure country market dynamics are accurately reflected and a consistent global output.
To find out more and to read further insight from the team click here