Guidelines

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.

Performance measurement

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.
 

As described in module 4 of the INREV guidelines, INREV’s objective in establishing these guidelines is to provide managers with guidance on how to calculate and disclose an INREV NAV in financial reports of non-listed European real estate vehicles. This should lead to transparency and comparability of the performance of different types of vehicles.

One of the purposes of reporting is to present investors with information relevant to the performance and valuation of their investment. The NAV derived from generally accepted accounting principles (GAAP), including IFRS, does not necessarily fulfil this objective. The INREV guidelines have therefore been prepared to provide an industry specific framework to enable managers to calculate a more meaningful adjusted NAV.

For the sake of clarity, all of the adjustments presented in the guidelines are based on IFRS. However, IFRS also offer some options and INREV adjustments may differ based on the selected option (i.e: cost versus fair value). Consequently, the guidelines are describing all the adjustments which should be done in order to compute an INREV NAV.

Taking this into consideration, it is not mandatory to first calculate an IFRS NAV, adjustments can be applied directly to the chosen GAAP as long as the fund manager clearly understands the purpose of the adjustments and amends the adjustments accordingly.

If the adjustments are performed correctly, the INREV NAV should be the same whatever the initial starting point GAAP was.
 

How can fund managers and investors access their own materiality and disclose this?

Calculating INREV NAV, the question might arise if a certain suggested INREV NAV adjustment would have a material impact on the total INREV NAV.

The reason might be that a fund manager has to take some effort to collect, assess, calculate and evaluate all data and information that is needed to come to a correct INREV NAV Adjustment with sufficient disclosure.

Expecting only immaterial effects and considering the cost-benefit-ratio fund managers might want to decide not to include a certain adjustment.

INREV does not feel to be in the position to determine an accepted amount or % of materiality for INREV NAV Adjustments since materiality level could be different for each vehicle, fund manager, investor or other user of the INREV NAV (for example indices).

Guidance on Materiality can be found in the International Standard on Auditing (ISA) 320: Materiality in Planning and Performing an Audit.
 

Financial reporting frameworks often discuss the concept of materiality in the context of the preparation and presentation of financial statements. Although the topic is approached in different terms, it is generally explained that:

• Misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements;
• Judgments about materiality are made in light of surrounding circumstances, and are affected by the size or nature of a misstatement, or a combination of both; and
• Judgments about matters that are material to users of the financial statements are based on a consideration of the common financial information needs of users as a group. The possible effect of misstatements on specific individual users, whose needs may vary widely, is not considered.

Determining materiality involves the exercise of professional judgment. A percentage is often applied to a chosen point of reference as a starting point in determining materiality for the financial statements/INREV NAV as a whole.

In the case of a regulated vehicle, the determination of materiality for the financial statements/adjusted NAV, INREV NAV as a whole (and, if applicable, materiality level or levels for particular classes of transactions, account balances, INREV NAV adjustments or disclosures) is/might therefore be influenced by law, regulation or other authority.

Based on circumstances a fund manager could assess if there is a need for a materiality. The materiality could be used to decide not to include certain adjustments.

Since assessing materiality levels might be a complex exercise, INREV recommends to request the auditor of the vehicle what the specific materiality is that he is using for the audit of the financial statements as a whole.

If a fund manager for what so ever reason does not want to include one or more adjustments, the impact on the total INREV NAV should be assessed as a whole. Leaving out one or more individual immaterial adjustments can sum up to a total material error

Further guidance on determining materiality can be found on the website of www.ifac.org.

If the fund manager decided not to include an adjustment, since he expects that leaving out that adjustment should not have a material effect on the INREV NAV in total, proper disclose should be provided.

The fund manager shall include in the disclosure notes to the INREV NAV calculation sufficient background of his decision and the following amounts and the factors considered in their determination:

1. Which adjustments are not included as a result of materiality;
2. What the rational is for not included these adjustments;
3. A statement that in the opinion of the fund manager not including the(se) adjustment(s) does not have a material effect on the INREV NAV as a whole;
4. If applicable, the materiality level or levels for particular classes of transactions, account balances, INREV NAV adjustments or disclosures

VERNI Real Estate S.A. - and notes

The Balance sheet and Profit and Loss account of VERNI Real Estate S.A. are prepared according to IFRS accounting principles.

The Balance sheet and Profit and Loss account of VERNI Real Estate S.A. are prepared according to IFRS accounting principles.

Accounting principle IFRS

Current and deferred income tax

The tax expense for the period comprises current and deferred tax. Tax is recognised in the income statement, except to the extent that it relates to items recognised directly in other comprehensive income or equity - in which case, the tax is also recognised in other comprehensive income or equity.  

The current income tax charge is calculated on the basis of the tax laws enacted or substantively enacted at the date of the statement of financial position in the countries where the Group operates. Management periodically evaluates positions taken in tax returns with respect to situations in which applicable tax regulation is subject to interpretation, and establishes provisions where appropriate on the basis of amounts expected to be paid to the tax authorities.

Deferred income tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. However, deferred income tax is not accounted for if it arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss. Deferred income tax is determined using tax rates (and laws) that have been enacted or substantially enacted by the date of the statement of financial position and are expected to apply when the related deferred income tax asset is realised or the deferred income tax liability is settled.

Deferred income tax assets are recognised to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilised.

The carrying value of the Group’s investment property is assumed to be realised by sale at the end of use. The capital gains tax rate applied is that which would apply on a direct sale of the property recorded in the consolidated statement of financial position regardless of whether the Group would structure the sale via the disposal of the subsidiary holding the asset, to which a different tax rate may apply. The deferred tax is then calculated based on the respective temporary differences and tax consequences arising from recovery through sale.

Deferred income tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets against current tax liabilities and when the deferred income taxes assets and liabilities relate to income taxes levied by the same taxation authority on either the same taxable entity or different taxable entities where there is an intention to settle the balances on a net basis.

Initial recognition exemption

DTL should be recognized for all taxable temporary differences, except when DTL arises from [IAS12.R15]:

1. The initial recognition of goodwill or;
2. The initial recognition of an asset or liability in a transaction which:

• is not a business combination and
• at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss)

No deferred tax liability should then be recognised because of the initial recognition exemption rule.

INREV NAV principle on deferred taxes

(Revaluation to fair value of deferred taxes and tax effect of INREV NAV adjustments)

Revaluation to fair value of deferred taxes and tax effect of INREV NAV adjustments Under IFRS, deferred tax assets and liabilities are measured at the nominal statutory tax rate.  

The manner in which the vehicle expects to realise deferred tax (for example, for investment properties through share sales rather than direct property sales) is generally not taken into consideration.   

The adjustment represents the impact on the NAV of the difference between the amount determined in accordance with IFRS and the estimate of deferred tax which takes into account the expected manner of settlement (i.e., when tax structures and the intended method of disposals or settlement of assets and liabilities have been applied to reduce the actual tax liability).  

Disclosures should include an overview of the tax structure including, for instance, details of the property ownership structure, key assumptions and broad parameters used for estimating deferred taxes for each country, the maximum deferred tax amount estimated assuming only asset sales (i.e., without taking into account the intended method of disposal) and the approximate tax rates used.

It is possible that the estimate of the amount of the adjustment required to bring the deferred tax liability related to property disposals to fair value could have a large impact on the INREV NAV. Since tax structures may differ from vehicle to vehicle, significant judgement is required and the mechanics of the calculation methodology for this adjustment may vary from vehicle to vehicle. Other components of the overall deferred tax adjustment require less judgement and are more mechanical in nature.  

This adjustment should include a full assessment of the tax impact on NAV of INREV NAV adjustments.

As with IFRS, deferred tax balances are not discounted to take into account time value of money.

Tax structure

• A fund is structured that it has 6 properties in different countries.
• These are held via 4 SPV's.

[1] Due to initial recognition exemption (FV at acquisition 45,000,000)
 

How should this adjustment be calculated? Is it appropriate to calculate this as a fixed percentage (e.g., 50%) of the deferred tax liability calculated for the vehicle under IFRS/local GAAP on a portfolio basis or any other aggregate basis?

The rationale behind this adjustment is that under IFRS (and many other GAAPs) deferred tax liabilities are measured at the nominal statutory tax rate. The manner in which a vehicle expects to settle deferred tax is generally not taken into consideration. Accordingly, the provision calculated on this basis may not be representative of the fair value of deferred tax liabilities (i.e., the actual amounts expected to be crystallised upon disposal of the property assets).

In calculating the adjustment of the fair value of the liability, based on the expected manner of settlement, the adjustment should be assessed on an asset-by-asset basis.

For each asset, therefore, consideration should be given as to the most likely form of disposal (e.g., asset deal or share deal) based on the intended disposal method and tax structuring of the asset as well as market conditions relevant to that property as at the date of calculation. Assumption of changes in disposal method based on as-yet unrealised future changes in market conditions are considered too subjective for the purposes of calculating the INREV NAV adjustments. If applicable, the history of the entity with regard to disposals should also be considered. The fair value of the deferred tax liability is then calculated in accordance with the assessed manner of settlement as well as the applicable rates at which the transaction would be taxed. IFRS allows only the rates that have been enacted or substantially enacted at the balance sheet date to be used whereas rates which have been enacted or substantially enacted after the balance sheet date can be used for the purposes of calculating the INREV NAV adjustment.

The calculation should also take into account any discounts to the sale price of a property sold via a share deal that are likely to be granted. For example, it may be that the sale of the shares of the property-owning entity is exempt from tax (or attracts minimal tax) but a deduction in respect of the latent capital gain within the property owning entity is made in arriving at the sale price. This amount in addition to any tax likely to crystallise on the disposal transaction should be taken into account when calculating the INREV NAV adjustment.

On this basis, therefore, a fixed percentage approach as outlined above will not be appropriate unless it represents a reasonable estimate of the adjustment required in respect of the deferred tax liability for each of the individual properties in the portfolio.

It is imperative to ensure that the calculation of the adjustment, either in part or in full, is not already included within the deferred tax liability calculated for the vehicle under IFRS/local GAAP, so as to avoid double-counting of the adjustment. Care should also be taken to ensure that there is no double-counting between this adjustment and the INREV adjustment on transfer taxes with regard to the valuation of property. For avoidance of doubt, transfer taxes should not be included within the scope of the deferred taxation adjustment calculation.

Given the subjective and complex nature of this calculation, therefore, it is recommended that managers document a formal internal policy with regard to the calculation methodology and review the policy on an ongoing basis (for example, with respect to changes in tax law and market conditions) in order to ensure that it remains appropriate. Disclosure should be given on the overall tax structure, including the overall ownership structure, key assumptions and broad parameters for each country, what the maximum taxation calculation would be on a traditional basis (i.e., without tax structures) and the approximate tax rate as a percentage.
 

How should this adjustment be calculated? Is it appropriate to compute this as a fixed percentage (e.g., 50%) of the transfer taxes for the vehicle under IFRS/local GAAP?

The calculation of the adjustment to the deduction of transfer tax (and other purchaser’s costs) inherent in the property valuation based on the expected manner of settlement, should be assessed on an asset-by-asset basis.

For each asset, therefore, consideration should be given as to the most likely form of disposal (e.g., asset deal or share deal) based on the intended disposal method and tax structuring of the asset as well as market conditions relevant to that property. If applicable, the history of the entity with regard to disposals and the agreed allocation of the tax burden between the seller and the purchaser should also be considered. This is the same rationale as for the calculation of the deferred tax liability adjustment. Where the assessed disposal method would result in a reduction in the transfer taxes (and purchaser’s costs) in the fair valuation of the property, this adjustment is made in arriving at the INREV NAV. However, the adjustment should only be included to the extent to which it is not already included in the property valuation, in order to avoid double-counting.

For this reason it is important that transfer taxes and other purchaser’s costs are considered as separate components when computing the adjustment. The same reduction may not be appropriate in both cases. For example, a share deal disposal may result in lower transfer taxes but may, in fact, increase the other purchaser’s costs due to the need for additional legal expenditure and diligence required to complete any such deal.

On this basis, therefore, a fixed percentage approach as outlined above will not be appropriate unless it represents a reasonable estimate of the adjustment required for both transfer taxes and other purchaser’s costs for each of the individual properties in the portfolio.

Given the subjective and complex nature of this calculation, therefore, it is recommended that managers document a formal internal policy with regard to the calculation methodology and review the policy on an ongoing basis (for example, with respect to changes in tax law and market conditions) in order to ensure that it remains appropriate. Adequate disclosures should also be provided so that users of the financial information can understand the calculation methodology with regard to the adjustment, as well as the key assumptions that the manager has made in the calculation and how the manager expects to utilise this additional value based on the current structure and market circumstances.
 

How should the INREV Guidelines be applied when valuing an entity’s investment in an associate/joint venture which is accounted for in the IFRS/local GAAP accounts of the entity (using either the equity method or proportionate consolidation)?

For the purposes of the INREV NAV, management’s best estimate of the fair value of the entity’s holding in the associate/joint venture should be used. Depending on the type of investment there will be a hierarchy of valuation methods in order to assess this:

1.   If the investment is quoted on an active market then the fair value should be calculated using the quoted price as at the calculation date;

2.   For investments in vehicles where there is a right of redemption at a contractually set NAV, then this should be used to value the holding irrespective of whether this NAV is consistent with INREV Guidelines;

3.   If the investment is in a closed end vehicle or a similar type of entity and there is no fixed redemption price or listed price then the fair value of the holding should be estimated so as to be consistent with INREV Guidelines;

4.   If there is not sufficient information available to compute the INREV NAV of the investment then another valuation technique should be used including, for example, an estimate based on recent comparable transactions if these are available.
 

Should the INREV NAV calculation include a portfolio premium/discount where, for example, the independent appraiser’s valuation report includes a statement that the portfolio as a whole would command a premium/discount in addition/decrease to/of the individually appraised values of each property?

The portfolio premium/discount should not be included in the INREV adjusted NAV and, according to the INREV Guidelines for property valuation, should not be included within the fair value of property. Nevertheless it is recommended that any such premium or discount be disclosed separately.
 

Is it not the case that, for open end vehicles, there is no need for fair valuations for hedging derivatives on the basis that upon maturity the value of these should be nil?

For both closed end and open end vehicles, the diluted INREV NAV should reflect all hedging derivatives at their fair value.
 

For INREV NAV calculation purposes, capitalised debt arrangement fees and costs should not be considered when the fair value of the loan is compared with the carrying amount at balance sheet date. This is because the debt arrangement fees and costs are netted with the related financial instrument.

The fair value of the financial liability should be compared with the long- and short-term part of the principal amount still open at balance sheet date, also referred to as the nominal value of the financial instrument.

Rationale

Based on various technical questions and debates from within the INREV community on this topic, INREV notes that practitioners use different approaches regarding the treatment of debt arrangement fees and costs for the following INREV NAV adjustment j) Revaluation to fair value of financial assets and financial liabilities.

Background

Under IFRS, financial liabilities within the scope of IFRS 9 are measured at:

• Financial liabilities at fair value through profit or loss
• Financial liabilities at amortised cost.

Financial liabilities are generally classified and measured at amortised cost, unless they meet the criteria for classification at fair value through profit or loss.

In this Q&A, we initially focus on financial liabilities measured at amortised cost and then on financial liabilities at fair value through profit or loss.

Initial measurement at initial recognition: an entity shall measure a financial liability at its fair value plus or minus, in the case of a financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the issue of the financial liability.

Debt arrangement expenses includes fees and commission paid to agents (including employees acting as selling agents), advisers, brokers and dealers, levies by regulatory agencies and security exchanges, and transfer taxes and duties. Debt arrangement expenses do not include debt premiums or discounts, or internal administrative or holding costs.

Reference is made to the INREV Global Definitions Database (GDD) in respect to debt arrangement costs and debt arrangement fees.

In the amortised cost approach after initial recognition, the amount at which the financial asset or financial liability is measured at initial recognition minus the principal repayments, plus or minus the cumulative amortisation, using the effective interest method of any difference between that initial amount and the maturity amount and, for financial assets, adjusted for any loss allowance.

The effective interest method that is used in the calculation of the amortised cost of a financial asset or a financial liability and in the allocation and recognition of the interest revenue or interest expense in profit or loss over the relevant period.

When applying the effective interest method, an entity generally amortises any fees, points paid or received, transaction costs and other premiums or discounts that are included in the calculation of the effective interest rate over the expected life of the financial instrument.

Treatment of capitalised debt arrangement expenses

Based on these assumptions, when the debt position is accounted for at amortised cost, the debt arrangement expenses remaining to be amortised should be considered.

INREV NAV should be adjusted for the spreading of costs that will benefit different generations of investors. The assessment on how to consider the capitalised debt arrangement expenses in the INREV NAV should be based on this principle.

Under IFRS, when applying the effective interest method, an entity generally amortises any fees and transaction costs that are included in the calculation of the effective interest rate over the expected life of the financial instrument. Therefore, the treatment for the capitalised debt arrangement expenses under IFRS is already in line with the INREV NAV principle of spreading one-off costs over time to benefit different generations of investors.

Example

Calculation of the adjustment:

As previously indicated, the capitalised debt arrangement cost should not be taken into account when the fair value of the loan is compared with the carrying amount at balance sheet date.

As the current market fixed interest is lower than the actual fixed rate, the fair value is more than the remaining principal amount. As a result, the INREV NAV adjustment is a negative adjustment of € 10 million.

Accounting of financial liability at fair value

Under IFRS 9, debt instruments under certain circumstances can be measured at fair value through Profit and Loss. However, the accounting of debt instruments at fair value is not a common approach.

All financial instruments are initially measured at fair value plus or minus transaction costs. As a result, for financial liability at fair value through profit or loss, the debt arrangement fees and costs are not capitalised and directly expensed in Profit and Loss.

In this model, the debt arrangement fees and costs are directly expensed and a reversal is expected to bring the accounting of the debt arrangement cost in line with the effective interest method.

Therefore, a calculation should be made to determine the amount of unamortised debt arrangement fees and costs and if an effective interest method be used. This unamortised part should be positively corrected in the NAV to bring it in line with the accounting principles.

As the debt is already accounted for at fair value, no adjustment to bring the debt to fair value is expected for this debt category, except for the unamortised debt arrangement fees and costs.

Local GAAP

If local GAAP prescribe other accounting treatments on the debt arrangement costs, an assessment should be made how the debt arrangement cost should have been accounted for under the effective interest method. An adjustment should be made to bring the position of these debt arrangement cost in line.

Depending on the accounting treatment (expensed, booked through equity or capitalised with different amortisation methodology), the adjustment should include the proper accounting of the spreading of the debt arrangement cost.

Straight-lined instead of effective interest

If a financial statement preparer from a materiality perspective did not properly account for the amortisation of debt arrangement expenses in line with the effective interest method (e.g. straight-lined over the term of the debt), it is expected from a materiality perspective when preparing the INREV NAV that the same reasoning/approach would be acceptable.

For debt arrangement cost that are expensed and expected to be reversed for INREV NAV, this practical expedient could be used. The debt arrangement cost could be amortised on a straight-lined basis if it is to be expected that the effective interest method would not lead to a material difference in the INREV NAV.

How is forward purchase recognised in INREV NAV?

Definition:

Forward purchase: A contractual arrangement between an investment vehicle and a developer to develop a real asset (irrespective of whether or not the land is owned or leased by the investment vehicle) at a determined price with delivery in the future.

Forward funding: A subset of forward purchase, forward funding is a specific contractual agreement with a developer where the investment vehicle will finance the development from start to completion with the end goal of contributing the real asset to the investment vehicle.
Financing arrangements without an automatic transfer of the real asset (once construction is completed) to the investment vehicle are not seen as a forward purchase.

The actual transfer of the real asset can have different forms such as a direct contribution of the real asset to the investment vehicle or an indirect contribution via a transfer of ownership rights of an entity that owns the real asset.

Assessment for inclusion into INREV NAV:

INREV NAV reflects a more accurate economic value of the investment (units) based on the fair value of the underlying assets and liabilities, as at the balance sheet date, as adjusted for the spreading of costs that will benefit different generations of investors.
Based on this principle, after certain criteria are met (for instance more than 50% probability of completion of the development), the more accurate economic value of a forward purchase should be taken into consideration in the calculation of INREV NAV, also in cases where under IFRS or other GAAP no assets are accounted for at balance sheet date.

Forward purchase arrangements can take various legal forms under different terms and conditions. For assessing whether a forward purchase arrangement should be accounted for, at fair value, when calculating an INREV NAV, three main aspects should be considered by the investment manager:

• Legal rights to purchase the real asset once construction is completed;
• Probability to start the development project and complete it according to plan;
• Determining a reliable fair value for the investment property under construction (reference is made to IVS/ RICS, and the Property Valuation module of the INREV Guidelines).

In instances where the land and respective development are recognized as an asset in the vehicle’s financial statements throughout the development stage, no additional adjustment may be required when calculating an INREV NAV. If the land and respective development are recognized as a financial instrument or prepayment in the vehicle’s financial statements, or in cases where recognition of the real estate asset occurs at completion (when it is contributed to the fund balance sheet), additional adjustments should be considered when calculating an INREV NAV.
Irrespective of the legal contracts and forms, an assessment should be made by the investment manager as to whether the actual terms and conditions of their particular forward purchase arrangement apply to the considerations included in this Q&A.

Where to reflect forward purchase adjustments into the INREV NAV?

There is currently no specific INREV NAV adjustment line for forward purchase arrangements.
The investment manager should include any additional adjustments related to Forward Purchase arrangements in the calculation of INREV NAV under the INREV NAV adjustment N) Contractual fees.

Contractual arrangements may not meet the criteria for recognition as an asset, provision or liability in accordance with IFRS / other GAAP at reporting date. The adjustment will then represent the impact on NAV of the revaluation of contractual arrangements to fair value.

To comply with the INREV NAV requirements, financial liabilities, including debt obligations should be measured at fair value, if not yet accounted for at fair value by the accounting standards of the vehicle. How should members calculate the fair value of debt obligations, and what are the most common methodologies that should be used?

Debt instruments, unless traded on an active market (where the fair value is readily available) or unless non-performing, are commonly valued using a discounted cash flow (DCF) valuation method. Cashflows are derived from the contractual terms of the loan, be it fixed or floating rate based, with or without prepayments. For the floating rate, one has to calculate the forward rates based on the floating rate index for each future interest rate period and compute the cashflows accordingly.

The discount rate would be typically driven by both market conditions and credit risk profile. The market conditions element would reflect the risk-free rate (currency and debt maturity specific). The credit risk element would be borrower-specific and based on default probabilities/ credit default spreads of the borrower (or similar borrower profile).

The credit risk can be derived from the initial debt placement but would require an update for any changes in the borrower’s credit risk profile. Observable transactions, when available, can be used to corroborate the results of the DCF approach. Examples of this can be found  here.

Amortised cost (determined in accordance with the accounting standards, eg IFRS) is not an appropriate estimation of the fair value of debt, even though it may approximate to the fair value in some particular circumstances, such as immediately after the debt instrument’s date of issuance. Please refer IVS 500 Financial Instruments (IVS 101 Scope of Work, para 20.3.(d), IVS 102 Investigations and Compliance for more information

For the purposes of calculating INREV NAV, INREV does not prescribe one specific or preferred methodology for the revaluation of debt obligations to fair value. Each financial instrument has its own characteristics and market circumstances might be different over time. Furthermore, as the adjustment [j) Revaluation to fair value of financial assets and liabilities] may have a material impact on the total INREV NAV, the investment manager should assess if an external expert should be used for the assessment of such adjustment to INREV NAV and/or the NAV used for pricing purposes for open ended funds. Regardless of the methodology used, the results of this process along with the key assumptions should be transparently reported to investors.