Guest blog by Dominic Burke, CBRE

Introduction

The 10 largest companies in the Fortune Global 500, by annual revenue, report property assets on their balance sheet worth in excess of $100 billion. But current accounting practice means the figures being reported may differ significantly from reality.

There is growing pressure and focus on corporates and their auditors to provide greater transparency around accounts, with shareholders increasingly interrogating firms’ accounting procedures. For many corporates, owned real estate amounts to a large proportion of their balance sheet and significantly impacts operational business strategy. Yet standard practice is to hold these assets at a figure which does not reflect their true worth, potentially misleading investors and restricting business operations.

Current practice

Accounting guidelines allow companies to account for owned real estate assets at either ‘Fair Value’ or at cost. Occupiers typically account at cost, typically the price they bought or built the property for, depreciated down to a residual land value over a typical period of 30 to 50 years. This ensures annual accounts are not hit by swings in property values, and is more cost-effective when negating the requirement for annual asset valuations. However, while this method may be appropriate for other balance sheet items, real estate it doesn’t suit the nature of real estate.

Real estate has an established market, where properties are traded on a regular basis as well as being used as collateral for finance. Prices can change significantly in time and the price purchasers are willing to pay does not relate to the cost of construction. There are active markets for the majority of assets, so property can be valued reflecting what “the market” is prepared to pay. So, there is an argument that periodic assessments of “fair value” would be a more prudent approach to financial reporting than that of cost. Through a periodic, professional review of assets, risk can be managed and priced, as incorrect reporting of both assets and liabilities clearly does not provide shareholders with a clear picture of a company’s financial health.

Risks

Corporates are the world’s largest owners of commercial real estate, owning a vast number of assets. The value of these properties is in the trillions of dollars, though by accounting at cost there is a significant danger that companies aren’t showing their real value on the balance sheets. The fundamental principle that cost does not equal value is not being considered, nor is the volatile nature of the property market.

The real estate market is cyclical; organisations who do not reflect this risk either grossly under or over assessing the worth of their assets. There are numerous examples of industrial sites owned by manufacturing companies which now have higher and better uses – these corporates could be sitting on real estate worth significantly more than what is being reported.

The decision to invest in public companies is made based on information they provide, particularly their accounts. When the balance sheet does not reflect the true value of real estate by showing a value either higher or lower, there is a danger that investors are being misled and companies are either under or overvalued.

Cost accounting for real estate hides the true value of a company’s balance sheet, misleads investors and over or under values companies. Corporates who adopt a regular valuation programme that assesses the value of their freehold estate will provide stakeholders with the necessary transparency around the true value of their real estate.

About the Author

Dominic Burke leads the CBRE EMEA Corporate Valuation Services team. The team is dedicated to providing valuation advice to occupier clients on their owned real estate portfolio.
http://valuedinsights.cbre.co.uk/corporate-valuation-services/