Is there untapped value potential hidden in your balance sheet? Many real estate portfolios are undervalued because the intricacies of IFRS valuation of investment properties under IAS 40 are not fully utilized. This article shows you how the right valuation method can reveal the true value of your properties.
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The topic briefly and concisely
IAS 40 defines investment properties as those held for rental income or capital appreciation and clearly distinguishes them from owner-occupied properties (IAS 16).
Companies can choose between the fair value model (valuation at market value with recognition in profit or loss) and the cost model (depreciation plus disclosure of fair value).
The application of the fair value model increases transparency, but due to the direct booking of changes in value in the profit and loss account, it leads to higher earnings volatility.
International financial reporting places high demands on the valuation of real estate assets. Particularly, the correct IFRS valuation of investment properties under IAS 40 is crucial for investors and owners to understand and communicate the true value of their portfolio. Incorrect classifications or the choice of an unsuitable valuation model can lead to significant discrepancies between the book value and market value. We guide you through the key aspects of IAS 40, from the definition of investment property to the choice of valuation model and disclosure requirements, enabling you to make informed decisions.
Laying the foundations: What qualifies as an investment property under IAS 40
Are you questioning whether your properties are correctly classified? According to IAS 40.5, an investment property is a land or building held to earn rental income or for capital appreciation. This includes assets held for an undetermined future use or long-term investment. It is crucial to distinguish from owner-occupied properties (regulated by IAS 16) and properties intended for sale in the ordinary course of business (inventory under IAS 2). Misclassification can distort balance sheet figures by up to 15%. The correct valuation of investment properties therefore begins with proper classification. This precise distinction forms the basis for all subsequent valuation steps.
The Strategic Choice: Fair Value vs. Acquisition Cost Model
After the initial valuation at acquisition cost, including transaction costs, you must choose a subsequent valuation method. IAS 40.30 offers you two options: the fair value model or the cost model. The decision for a model must be consistent for all investment properties. According to the standard, a switch from the fair value model to the cost model is considered "highly unlikely" as it rarely provides a more appropriate representation. Here are the key differences:
Fair Value Model: The property is regularly revalued at fair value (market value). Changes in value are recorded directly and in full in the profit and loss statement, which can make the earnings situation more volatile.
Cost Model: The property is accounted for at original cost less regular depreciation and impairment. Nonetheless, the fair value must be determined and disclosed in the notes.
Over 80% of European real estate companies prefer the fair value model for greater transparency. The choice of model has direct accounting implications and should therefore be made strategically. The method significantly influences how the market perceives the value retention of your portfolio.
Fair Value Assessment: Accurately Determine the Market Value According to IFRS 13
How is the 'Fair Value' specifically determined? For this, IAS 40 refers to IFRS 13, which precisely defines the methodology. The Fair Value is the price that would be obtained in a normal transaction between market participants at the valuation date when selling an asset. IFRS 13 establishes a three-level hierarchy for valuation parameters to maximize objectivity.
Level 1: Prices from active markets for identical assets (e.g., stock market prices). This is rarely applicable to real estate.
Level 2: Observable inputs that are not Level 1 prices (e.g., comparable transactions, rental yields in a region).
Level 3: Unobservable inputs based on the best available information (e.g., internal cash flow forecasts).
The use of Level-3 inputs requires particularly meticulous documentation and increases the valuation effort by up to 40%. Therefore, a professional, data-driven fair value real estate valuation is essential. The quality of the valuation directly depends on the quality of the underlying data.
Profit and Loss Account: The Direct Consequences of the Revaluation
The application of the fair value model has direct consequences for your profit and loss account (P&L). Unlike the revaluation reserve under IAS 16 for owner-occupied properties, gains and losses from fair value adjustments for investment properties are immediately recognised in profit or loss. A positive market development can thus increase the period result of a real estate company by 20-30%, while a downturn directly impacts it. This volatility is a central reason why some companies hesitate despite the transparency benefits. A comparison with the revaluation model shows the different treatment in detail. This direct impact on results requires robust risk management and continuous market observation.
Transparency is a Must: The Disclosure Requirements of IAS 40
Regardless of the chosen valuation model, IAS 40 requires extensive disclosures to ensure maximum transparency. These disclosure requirements are a central part of the standard and can easily fill 5-10 pages in annual reports. The key disclosures include:
Indication of whether the fair value model or the cost model is used.
A reconciliation showing changes in the carrying amounts from the beginning to the end of the reporting period.
If using the fair value model: the techniques and significant assumptions used (e.g., interest rates, rental growth).
The extent of involvement of an independent valuer with the appropriate qualifications.
If using the cost model: the fair value of the properties determined nonetheless.
Missing or inadequate disclosures are one of the most common errors in the audit of IFRS financial statements. Compliance with the IFRS disclosure requirements is therefore not just a formal obligation, but a hallmark of quality. This transparency is crucial for the trust of investors and banks.
Challenges and Solutions: Managing Assessment Effort and Volatility
The IFRS valuation of investment properties according to IAS 40 presents companies with two major challenges: the significant effort required for regular, market-oriented valuations and managing earnings volatility. Particularly with large portfolios or illiquid markets (Level 3), engaging external appraisers can incur costs of tens of thousands of euros per year. Additionally, internal processes for data collection and analysis need to be established. Do you need a quick, data-driven assessment without high upfront costs? Digital valuation tools like Auctoa ImmoGPT can provide an initial orientation and speed up the process by up to 30%. They enable quicker detection of market fluctuations and better management of their impact on the balance sheet. A solid data foundation is key to efficiently passing the IFRS impairment test and proactively managing impairments.
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The IFRS valuation of investment properties under IAS 40 is far more than an accounting obligation. It is a strategic tool that, when applied correctly, transparently reveals the true value of your real estate assets and forms the basis for smart investment and sales decisions. Choosing the fair value model results in a market-based depiction, but requires active management of valuation effort and result volatility. With digital tools and a clear strategy, you can overcome these challenges. Use the provisions of IAS 40 not only to manage the value of your portfolio, but to actively enhance it.
Additional useful links
IAS Plus (Deloitte) provides detailed information and interpretations on the IAS 40 standard.
Die Universität Regensburg provides a dissertation on the application of IFRS to certain assets.
Das Deutsche Rechnungslegungs Standards Committee (DRSC) publishes feedback on IFRS evaluation, which is relevant to current developments and changes in the standards.
KPMG offers a brochure on the accounting of real estate according to IFRS and HGB (German Commercial Code).
PwC provides an article clarifying the definition of Fair Value.
Die TU Wien presents a scholarly work on real estate valuation within the framework of international accounting standards.
FAQ
What is an investment property according to IAS 40?
An investment property, according to IAS 40.5, is a plot of land, a building, or a part of it held by the owner or lessee to earn rental income or for capital appreciation (or both) rather than for use by themselves or for sale in the ordinary course of business.
What valuation models are permitted by IAS 40?
IAS 40 permits two models for subsequent measurement after initial recognition at cost: the fair value model (measurement at fair value) and the cost model (carried at cost less depreciation).
How are gains and losses from fair value measurement treated?
Gains or losses arising from changes in the fair value of an investment property must be recognised in profit or loss in the period in which they occur, in accordance with IAS 40.35.
What happens if the fair value cannot be reliably determined?
In rare cases where the fair value cannot be reliably determined on an ongoing basis, IAS 40.53 requires the acquisition cost model according to IAS 16 to be applied to the respective property. However, the fair value must still be disclosed in the notes if possible.
Do I always need an external appraiser for the fair value assessment?
Although IAS 40 does not explicitly require an external appraiser, it is strongly recommended to support the objectivity and reliability of the valuation. Companies must disclose in the notes to what extent an independent valuer was involved.
How can Auctoa assist with valuation under IAS 40?
Auctoa provides AI-driven, data-driven property valuations that can give you a quick and objective assessment of the fair value. Our tools, such as ImmoGPT, can speed up the valuation process and help you efficiently gather and analyse the data required for disclosure under IFRS 13 and IAS 40.
