Under Accounting Guidelines Board Guideline (RTJ) 6, an investment property is not simply “a building on the balance sheet”, but an asset held to earn rental income, for capital appreciation, or both.
We provide companies with a brief overview of when the value of an investment property must be reviewed, what must be taken into account when measuring fair value under RTJ 6, and what the most common pitfalls are.
When should the fair value of an investment property be reviewed?
The accounting treatment of an investment property depends on the accounting policy selected. RTJ 6 allows the use of either the fair value model or the cost model.
Under the fair value model, the asset is measured at market-based value at each reporting date. Changes in value are recognised directly in the income statement and no depreciation is charged.
Under the cost model, investment property is accounted for similarly to tangible fixed assets. The carrying amount is based on acquisition cost less accumulated depreciation and any impairment losses.
It is important to understand that if a company decides to apply the fair value model, valuation becomes an ongoing part of financial reporting and management practice.
What must be considered when measuring fair value and what are common mistakes?
As a manager, it is worth considering the following questions:
1. Does the value reflect the market rather than the company’s or owner’s expectations?
- Was the valuation based on actual market information (transactions, rental levels, yield rates and the general economic environment)?
- Have investor-specific assumptions and expectations that are not in line with market conditions been excluded?
- Has the price of a transaction under special conditions been excluded?
This is the first and most common area of error, as value is often determined based on investor expectations or property-specific characteristics rather than market conditions.
2. Which valuation method is used?
- The best indicator of a property’s value is its market value, available on an active open market for an identical asset.
- In the absence of an active market, value may be estimated based on recent market transactions involving similar properties or by using the discounted cash flow (DCF) method.
3. Which cash flows are included in the DCF model?
- It is essential to assess the asset’s ability to generate future cash flows and to consider both income and expenses associated with owning and operating the property.
- All material cash flows must be included in the valuation model: rental income including vacancy and potential incentives, property-related operating costs, future improvements or capital expenditure (CAPEX), and the terminal value.
4. Has the highest and best use of the asset been considered?
- Is the current use of the property its highest and best use, or does a realistic alternative exist in the market that would create greater value?
- Have legal (planning), physical and financial feasibility aspects been considered?
5. Is the valuation prepared as at the reporting date?
- The valuation must reflect the circumstances existing at the reporting date. If the valuation was performed at an earlier date, it must be assessed whether interim events (market changes, new contracts, major renovations) have affected the property’s value.
A common misconception is that if there are no plans to sell the asset, no new valuation is required, regardless of significant market changes or major renovation works.
If a valuation report has been commissioned for commercial real estate, the valuer must hold a Level 7 professional qualification certificate.
6. Selling costs
- The treatment of selling costs depends on the applicable accounting standard and the classification of the asset. Under RTJ 6, the fair value of an investment property is presented without deducting selling costs. In practice, valuers often present value after deducting estimated selling costs; therefore, in reports prepared under RTJ, the CFO or accountant must adjust the amount stated in the valuation report accordingly. Under International Financial Reporting Standards (IFRS), selling costs are deducted in certain cases, but not when measuring the fair value of investment property under RTJ.
This is also one of the most common areas of error.
If there are clear answers to these questions, an investment property becomes, from the company’s perspective, not merely “a building on the balance sheet”, but a consciously managed investment whose fair value supports owners’ decisions, financing, and reliable financial reporting.
