What is the rationale behind the adjustments in determining the INREV NAV whereby set-up costs and acquisition expenses are capitalised and amortised over five years? Do these adjustments not simply inflate the NAV of the entity given that the property portfolio is already included at its fair value in the NAV calculation?
The initial main aim of the INREV NAV is to help compare vehicle performance across a peer group and for the valuation of the investment in the units for accounting purposes at the investor level.
During the initial INREV NAV project in 2007 it was decided after several workshops, interviews and the white paper process to have one INREV NAV for both open end and closed end vehicles, with the intention of increasing comparability. It was noted that for some adjustments the suggested treatment would not necessarily lead to the correct approach for certain types of vehicle. However, when measuring performance of different types of vehicle (such as in the INREV INDEX), comparability would be increased if all vehicles treated adjustments in the same way.
The initial rationale for capitalising and amortising set-up/acquisition expenses is to better reflect the duration of economic benefit to the vehicle of these costs. This is for both performance measurement and valuation of investments.
This was prompted by the fact that, under IFRS, set-up costs are charged immediately to income after the start/inception of a vehicle and under the fair value model, acquisition expenses of investment property are effectively charged to income when fair value is calculated at the first subsequent measurement date after acquisition – resulting in the so-called J-curve.
Based on the outcome of the analyses in 2007 it was INREV’s intention to use an adjusted NAV for performance measurement (including in the INREV Index) to mitigate the negative effects of the J-curve. If for performance measurement different types of vehicle, with different vintages, are compared in one index the treatment of set-up costs and acquisition expenses as a one-off expense would lead to an underperformance of that specific vehicle, in comparison with its point of reference, in the first years of the life of the vehicle (acquisition phase). For the years up to the disposal phase it would more easily outperform the point of reference, as the effects of the J-curve arising on new vehicles would lower the overall performance point of reference. During the disposal phase, a vehicle would generally underperform the point of reference as the one-off effects of the disposal costs would have a negative effect on the individual performance of the vehicle.
Valuation of units in investment vehicles
With the amortisation of set-up costs and property acquisition expenses the effect of the so-called “J-curve” can be eliminated in the valuation of units in investment vehicles. Some investors were using an adjusted NAV for valuation, others, at that time, were recording the investments at cost for the first three years and only starting to use IFRS NAV when the appreciation of real estate values had driven IFRS NAV above the initial cost price.
Furthermore, it was noted that investors were of the opinion that such expenses have a value, and were seen as part of the initial investment. These costs were directly incurred in order to receive direct returns from the rental income and hopefully indirect returns by way of value appreciation upon liquidation. This return would flow back to the investor during the whole holding period of an investment.