IAS 40 investment property, IFRS 13 disclosures, level 3 valuation

Capital & Counties Properties PLC – Annual report – 31 December 2019

Industry: real estate

13 PROPERTY PORTFOLIO
(A) INVESTMENT AND DEVELOPMENT PROPERTY

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  1. Included in ‘Other’ is the Group’s interest in Earls Court Properties and Empress State Building which were disposed of on 29 November 2019 and 26 March 2018 respectively. Details of the disposals is set out in note 10 ‘Discontinued Operation’.
  2. This relates to apartments at the Floral Court Collection in Covent Garden which had exchanged before 31 December 2018 and completed in early 2019.
  3. Loss on revaluation of £192.7 million (2018: £148.2 million) includes a loss on revaluation of £151.6 million (2018: £185.3 million) which relates to Earls Court Properties for the period prior to disposal which is included in the loss for discontinued operation in the consolidated income statement. The remainder of the loss, relating to continuing operations is recognised in the consolidated income statement within loss on revaluation and sale of investment and development property.

(B) MARKET VALUE RECONCILIATION OF TOTAL PROPERTY

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  1. The unrecognised surplus on trading property is shown for informational purposes only and is not a requirement of IFRS. Trading property continues to be measured at the lower of cost and net realisable value in the consolidated financial statements.

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  1. ‘Other’ includes the Group’s interest in Earls Court Properties which was disposed of on 29 November 2019.
  2. Included within investment and development property is £3.7 million of interest capitalised during the year on property under development.
  3. The unrecognised surplus on trading property is shown for informational purposes only and is not a requirement of IFRS. Trading property continues to be measured at the lower of cost and net realisable value in the consolidated financial statements.

At 31 December 2019, the Group was contractually committed to £7.0 million (2018: £22.4 million) of future expenditure for the purchase, construction, development and enhancement of investment, development and trading property. Refer to note 28 ‘Capital Commitments’ for further information on capital commitments.

The fair value of the Group’s investment, development and trading property at 31 December 2019 was determined by independent, appropriately qualified external valuers, JLL for Lillie Square and CBRE Ltd for the remainder of the Group’s property portfolio. The valuations conform to the Royal Institution of Chartered Surveyors (“RICS”) Valuation Professional Standards. Fees paid to valuers are based on fixed price contracts.

Each year the Executive Directors, on behalf of the Board, appoint the external valuers. The valuers are selected based upon their knowledge, independence and reputation for valuing assets such as those held by the Group.

Valuations are performed bi-annually and are performed consistently across all properties in the Group’s portfolio. At each reporting date appropriately qualified employees of the Group verify all significant inputs and review computational outputs. Valuers submit and present summary reports to the Group’s Audit Committee, with the Executive Directors reporting to the Board on the outcome of each valuation round.

Valuations take into account tenure, lease terms and structural condition. The inputs underlying the valuations include market rent or business profitability, likely incentives offered to tenants, forecast growth rates, yields, discount rates, construction costs including any site specific costs (for example Section 106), professional fees, planning fees, developer’s profit including contingencies, planning and construction timelines, lease re-gear costs, planning risk and sales prices based on known market transactions for similar properties or properties similar to those contemplated for development. As at 31 December 2019 all Covent Garden properties are valued under the income capitalisation technique.

Valuations are based on what is determined to be the highest and best use. When considering the highest and best use a valuer will consider, on a property by property basis, its actual and potential uses which are physically, legally and financially viable. Where the highest and best use differs from the existing use, the valuer will consider the cost and the likelihood of achieving and implementing this change in arriving at its valuation.

A number of the Group’s properties have been valued on the basis of their development potential which differs from their existing use. In respect of development valuations, the valuer ordinarily considers the gross development value of the completed scheme based upon assumptions of capital values, rental values and yields of the properties which would be created through the implementation of the development. Deductions are then made for anticipated costs, including an allowance for developer’s profit, before arriving at a valuation.

There are often restrictions on both freehold and leasehold property which could have a material impact on the realisation of these assets. The most significant of these occur when planning permission is required or when a credit facility is in place. These restrictions are factored into the property’s valuation by the external valuer. Refer to disclosures surrounding property risks on page 19.

Non-financial assets carried at fair value, as is the case for investment and development property held by the Group, are required to be analysed by level depending on the valuation method adopted under IFRS 13 ‘Fair Value Measurement’ (“IFRS 13”). Trading property is exempt from IFRS 13 disclosure requirements.

The different valuation levels are defined as:

Level 1: valuation based on quoted market prices traded in active markets;
Level 2: valuation based on inputs other than quoted prices included within Level 1 that maximise the use of observable data either directly or from market prices or indirectly derived from market prices; and
Level 3: where one or more inputs to valuation are not based on observable market data. Valuations at this level are more subjective and therefore more closely managed, including sensitivity analysis of inputs to valuation models.

When the degree of subjectivity or nature of the measurement inputs changes, consideration is given as to whether a transfer between fair value levels is deemed to have occurred. Unobservable data becoming observable market data would determine a transfer from Level 3 to Level 2. All investment and development properties held by the Group are classified as Level 3.

The following table sets out the valuation techniques used in the determination of market value of investment and development property on a property by property basis, as well as the key unobservable inputs used in the valuation models.

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  1. Estimated rental value and capital value are expressed per square foot on a net internal area basis. Construction costs including site specific costs expressed per square foot on a gross external area basis.

Covent Garden properties are valued under the income capitalisation method and if all other factors remained equal, an increase in estimated rental value of five per cent would result in an increased asset valuation of £114.7 million (2018: £118.3 million). A decrease in the estimated rental value of five per cent would result in a decreased asset value of £109.1 million (2018: £112.9 million). Conversely, an increased equivalent yield of 25 basis points would result in a decreased asset valuation of £168.8 million (2018: £172.2 million). A decreased equivalent yield of 25 basis points would result in an increased asset valuation of £192.8 million (2018: £197.0 million). These inputs are interdependent, partially determined by market conditions. The impact on the valuation could be mitigated by the interrelationship between the two inputs. An increase in estimated rental value occurring in conjunction with an increase in equivalent yield could result in no net impact to the valuation.

For Other properties valued under the income capitalisation method and if all other factors remained equal, an increase in estimated rental value of five per cent would result in an increased asset valuation of £0.1 million (2018: £1.2 million). A decrease in the estimated rental value of five per cent would result in a decreased asset value of £0.1 million (2018: £2.9 million). Conversely, an increased equivalent yield of 25 basis points would result in a decreased asset valuation of £0.1 million (2018: £2.1 million). A decreased equivalent yield of 25 basis points would result in an increased asset valuation of £0.1 million (2018: £2.4 million). These inputs are interdependent, partially determined by market conditions. The impact on the valuation could be mitigated by the interrelationship between the two inputs. An increase in estimated rental value occurring in conjunction with an increase in equivalent yield could result in no net impact to the valuation.

Properties valued under the residual development method and discounted cash flow approach related to properties held in Earls Court Properties. These properties were disposed of during the year. Sensitivities on these properties for the prior year during which these were held is included below for completeness. For properties held under the residual development method, an increase in the estimated construction costs of 10 per cent would have resulted in a decrease in the asset valuation of £170.9 million and a decrease of 10 per cent would have resulted in an increase in the asset valuation of £170.6 million. An increase in the developer’s profit of one percentage point would have resulted in a decrease in the asset valuation of £18.6 million and a decrease of one percentage point would have resulted in an increase in the asset valuation of £18.8 million. An increased finance rate of 25 basis points would have resulted in a decreased asset valuation of £18.1 million and a decrease of 25 basis points would result in an increased asset valuation of £17.3 million. Conversely, an increase in the capital value per square foot of five per cent would have resulted in an increase in the asset valuation of £107.8 million and a decrease of five per cent would result in a decrease in the asset valuation of £107.9 million. The above inputs are interdependent, partially determined by market conditions. The impact on the valuation could be mitigated by the interrelationship between these inputs.

An increase in the discount rate included in a discount cash flow valuation of 10 per cent would have resulted in a decrease in the asset valuation of £0.2 million. A decrease in the discount rate included in a discount cash flow valuation of 10 per cent would have resulted in an increase in the asset valuation of £0.3 million.

28 CAPITAL COMMITMENTS
At 31 December 2019, the Group was contractually committed to £7.0 million (2018: £22.4 million) of future expenditure for the purchase, construction, development and enhancement of investment, development and trading property. All of the £7.0 million committed is committed 2020 expenditure. The prior year capital commitments included commitments of £18.6 million relating to Earls Court Properties which was disposed of during the year.

The Group’s share of joint venture capital commitments arising on LSJV amounts to £6.6 million (2018: £32.4 million).