Guidelines

To comply with INREV NAV requirements, how should adjustments be made to recorded goodwill, particularly concerning the difference between full recognition of deferred tax, purchaser’s costs, or similar items in the IFRS accounts (which typically do not consider the likely or intended method of subsequent exit), and the economic value attributed to these items in the actual purchase price? Additionally, how should other components of goodwill be treated in the INREV NAV?

Background:
When INREV NAV was established, investors predominantly invested in core or core-plus real estate vehicles. In these vehicles, besides rental activities, no significant operational activities were undertaken.

Acquisition accounting under IFRS 3 business combination:
Goodwill arises in accounting when the acquisition of real estate activities or portfolios is classified as a business combination. This results in a difference between the purchase price paid and the IFRS NAV of the acquired undertakings, following guidelines under IFRS 3. IFRS 3 applies to transactions or events that meet the definition of a business combination.

If the acquisition of a real estate portfolio or activities (an asset or a group of assets) qualifies as a business combination, the acquirer should measure the identifiable assets acquired and the liabilities assumed at their acquisition-date fair values. The acquirer should recognise and measure deferred tax assets or liabilities arising from the assets acquired and liabilities assumed in a business combination, in accordance with IAS 12 Income Taxes.

Effects of the valuation of deferred taxes in the considerations paid:
When acquiring a real estate portfolio via a share deal, an agreement is usually made between the buyer and the seller regarding the valuation of the respective deferred tax liability. Since the deferred tax liability is not immediately payable after the transfer of the shares, a discount on its nominal valuation is often negotiated. Such a discount means that the consideration paid will be higher than the IFRS NAV-based fair value of assets and liabilities, accounting for the deferred liability at fair value.

Example:
Consider the purchase of a legal entity classified as a business combination under IFRS 3. The entity holds a real estate portfolio with a fair value of €20,000 and a tax book value of €12,000. There is no external debt, cash, or other working capital accounts. The tax rate is 25%, resulting in a deferred tax liability of €2,000. The net asset value of the entity based on IFRS is €18,000. The buyer and seller agree on a price for the entity shares based on the fair value of the portfolio of €20,000 and a 50% discount on the deferred tax liability. The agreed consideration for the shares amounts to €19,000.

In the purchase price allocation under IFRS, the deferred tax liability should be accounted for at its nominal value of €2,000, resulting in the following assessment:

Expected adjustment under Adjustment r) Goodwill:
The part of any respective goodwill related to the difference between the full recognition of deferred tax, purchaser’s costs, or similar items in the IFRS accounts (which do not generally account for the likely or intended method of subsequent exit) should be written off in the INREV NAV to avoid double counting. These items typically are included and adjustment in p) Revaluation to fair value of deferred taxes and tax effects of INREV NAV adjustments, m) Acquisition expenses, and o) Revaluation to fair value of purchaser's cost savings, such as transfer taxes.

In the example above, the goodwill of €2,000 should be written off in the INREV NAV. Other components of goodwill resulting from an acquisition, such as an asset management organisation or other operational type of activities, should not be directly written off in the INREV NAV calculation. An impairment test should be conducted for these components of goodwill. If no impairment is necessary under IFRS, the amount will remain on the balance sheet. If impairment is required, it should be considered in the INREV NAV adjustment as well. If other GAAP’s are used as a starting point, reference should be made to the INREV NAV - GAAP Comparison Templates.

The question may arise whether other activities that drive goodwill or operating activities started after the acquisition should be accounted for at fair value under INREV NAV. INREV NAV should reflect an accurate economic value based on the fair value of underlying assets and liabilities as of the balance sheet date, adjusted for the distribution of costs benefiting different generations of investors.

Currently, INREV NAV does not allow the fair value of other operating activities or components of goodwill as described. The rationale at the time the INREV NAV was established and revised was that it would be complex and arbitrary and would lead to more volatility and valuation uncertainty in INREV NAV, for performance measurement, to be more specific. Including the fair value of other operating activities or components of goodwill in INREV NAV could breach the objectives of INREV NAV, which aims for transparency and comparability of performance across different vehicle types.

More investors invest via vehicles into operationally driven assets such as hotels, flex offices, student housing, life science, etc. (see INREV Operational Real Estate insights page). The actual value of these operational activities may not be reflected in the respective assets or in the INREV NAV, for example, brand proposition to end users, although they can create a brand value that can be leveraged for new markets.

Investment managers might conclude that, in addition to performance metrics based on INREV NAV, performance could be disclosed and calculated using different valuation techniques, especially if they lead to more reasonable and transparent performance measurements. These situations may arise when operational activities have a material impact on the result and performance of the vehicle. Alternative methodologies could include enterprise valuation of the vehicle itself.

When INREV NAV is used for valuation and trading purposes, the question may arise whether INREV NAV is reflecting a fair value of the units of the vehicle on light of pricing or fair value. In that case, a similar approach could be used (see INREV Governance Guideline G09).

If an alternative NAV or valuation is used, it should not be referred to as an INREV NAV.