Real Estate fund matters - Alfi

U6U UVALUATION 

ALFI WG Real Estate Investment Funds Sub-Committee - January 2009 

Frequently Asked Questions - Luxembourg 

Real Estate Investment Funds (“REIFs”) 

FAQ 1s Financial framework / Valuation of Properties / NAV / Financial Reporting 

Supplemental questions (January 2009) 

Due to current market conditions, a number of key issues and questions have been raised as regard to real estate funds and 

particularly in the context of the calculation of NAVs and the related production of financial statements. These are related to 

increased uncertainty with respect to the valuation of real estate and also the impact of current market conditions on other 

elements of the financial position of funds such as the “going concern“ assumption and ongoing liquidity. This is crucial both 

in regard to NAVs which are reported for informational and statutory purposes, and for NAVs that are used to price issues and 

redemptions, thus affecting the relative value of investors’ holdings in the fund. 

Contents 

UNCERTAINTY 2U 

U6.1U UWhat is valuation uncertainty?U 2 

U6.2U 

UWhat actions regarding financial reporting should be taken by the management of the fund 

relating to the increased uncertainty in the valuation of real estate?U 2 

U6.3U UHow recent should a valuation be to be relevant in current market conditions?U 3 

U6.4U 

UWhat other considerations should management take into account in current market 

conditions?U 

3 

U6.5U 

UHow may this impact the audit of financial statements of Luxembourg real estate funds?U 3 

U6.6U 

UWhat actions should be taken by the Central Administration / Custodian?U 

4 

This document reflects the general consensus of recent discussions with auditors, tax advisors, valuers, custodians and central 

administrators, together with reference to certain Best Practice Guides and Standards, including those of INREV, EPRA and 

EVCA. This is a supplement to the FAQ1-NAV paper published by ALFI in November 2008. 

The document takes the form of answers to frequently asked questions, primarily in respect of accounting and valuation 

issues, calculation of net asset values and the contents of financial statements including key disclosures. 

The answers to these frequently asked questions do not constitute regulations in Luxembourg or in any other jurisdiction and 

should be considered guidance on common practice. Answers are provided on the assumption that the applicable Generally 

Accepted Accounting Principles (GAAP) used is Luxembourg GAAP and/or International Financial Reporting Standards 

(IFRS), which are the most commonly used GAAPs in respect of Luxembourg domiciled real estate investment vehicles. In 

addition, answers are directed at regulated Luxembourg Real Estate Investment Funds (“REIFs”) (FCP, SICAV, SICAF, 

SICAR) and specifically do not address unregulated investment vehicles such as companies, partnerships and securitization 

vehicles, which may have different legal requirements. 

This document is being published by ALFI as a general guideline and while reasonable care has been taken in compiling the 

information, ALFI does not accept any liability for the guidelines and does not guarantee in any way that they will be 

appropriate to specific circumstances. Readers should take their own professional advice in order to decide how to operate 

individual REIFs. 

This document should be read in conjunction with the November 2008 ALFI publication REIFs FAQ 1 Financial 

framework / Valuation of Properties / NAV / Financial Reporting, Uand theU brochure Luxembourg Real Estate 

Investment Vehicles, which is prepared jointly by ALFI and the Luxembourg Bankers’ Association (ABBL) and 

gives general background information on the legal and taxation aspects of unregulated and regulated real estate 

vehicles domiciled in the Grand Duchy of Luxembourg. 

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6 0BUVALUATION UNCERTAINTY 

6.1 1BUWhat is valuation uncertainty? 

6.1.1 7BRecent financial and property market conditions, including the “credit crunch”, have reduced property 

transaction volumes significantly, in all global property markets. This market instability has increased 

uncertainty around any reported investment property fair value. 

6.1.2 8BPractically all regulated real estate funds in Luxembourg rely on independent valuation reports to determine the 

reported fair value of their investment property portfolio at their year-end and interim reporting dates. 

6.1.3 9BThe vast majority of Luxembourg Real Estate Investment Funds (“REIFs”) commission valuations according to 

the International Valuation Standards Council (“IVSC”) Best Practice guidelines and/or the Royal Institution of 

Chartered Surveyors (“RICS”) Appraisal and Valuation Standards (“the Red Book”). 

6.1.4 10BMaterial valuation uncertainty may arise from a variety of factors associated with a particular property, 

including but not limited to location, unusual characteristics, lack of current information available about the 

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property, development status, ongoing legal issues and market instability. Under RICS guidanceF F, valuation 

uncertainty paragraphs, if included, should not cause the management of the fund or its auditor to question the 

validity of the valuation, and should not amount to standard caveats or general disclaimers. 

6.1.5 11BDespite the RICS guidance, it is conceivable that valuation reports may contain emphasis of matter paragraphs 

making reference to specific circumstances relating to individual properties. It is also possible that valuation 

reports contain a qualification of the valuation or only provide a range of possible values. 

6.1.6 12BDue to significant uncertainties as described above, particularly market instability, valuers have recently and are 

indicating that they may continue to include ‘valuation uncertainty’ paragraphs in some valuation reports. Most 

of the uncertainty paragraphs seen to date do not caveat the valuation opinion provided. However, they do 

typically draw the reader’s attention to the financial backdrop against which the valuations have been assessed. 

6.2 2BUWhat actions regarding financial reporting should be taken by the management of the fund 

relating to the increased uncertainty in the valuation of real estate? 

6.2.1 13BManagement should review all the valuation reports received from independent valuers in order to understand 

the methods and assumptions used by the independent valuers to estimate fair value of the properties. This 

review should include an assessment whether the valuation reports contain only standard uncertainty paragraphs 

or whether the valuer has put a caveat on their valuations in any way. In addition management should check 

whether the conclusions reached by the independent valuer are not materially inconsistent with its own 

assessment and understanding of a particular market and with comparator market transactions. 

6.2.2 14BIn 

order to appropriately draw the reader’s attention to increased uncertainty cited in the valuers’ report (if any 

is stated), management should consider enhancing disclosures in the financial statements in the following areas: 

• the investment property note, which typically already includes disclosures on the valuers used by the 

company, which could be extended to describe special assumptions used in the valuation reports and any 

other relevant information highlighting the increased uncertainty of the real estate valuation as stipulated; 

• the accounting policy ‘valuation method’ note, if the valuation method used by the client or valuer has 

changed; 

• the critical accounting estimates and judgments disclosures, to highlight increased uncertainty surrounding 

real estate fair value estimates; 

• the disclosures around market risk and the impact on financial instruments that rely on covenant 

compliance. 

6.2.3 15BThese additional disclosures could include reference to some or all of the following topics depending on the 

particular situation: 

1 See RICS Red Book Guidance Note 5, and the ‘Valuation Uncertainty and Market Instability’ bulletin issued by RICS on 26 

November 2008. (http://www.rics.org/Practiceareas/Property/Valuation/val_uncertainty_f_271108.html) 

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• a sensitivity analysis on property yields or an indication of the range of potential valuation outcomes to the 

extent that the valuer is willing to provide this information within their valuation reports; and 

• a reproduction of the additional ‘valuation uncertainty’ wording included in the valuation report by the 

valuers if the report is not reproduced within the financial statements, or a suitable cross reference if it is. 

6.3 3BUHow recent should a valuation be to be relevant in current market conditions? 

6.3.1 16BLuxembourg REIF regulations indicate that a minimum frequency of annual property valuations is acceptable. 

Many REIFs have previously organized themselves on an annual valuation cycle, which has meant that real 

estate valuations that were used for financial reporting purposes were often commissioned several months or 

quarters before the reporting date. Due to the current volatility in the real estate market and the potential for 

significant change in values over time, excessively aged independent valuations do not seem any longer to be a 

prudent basis for financial reporting. 

6.3.2 17BIndependent valuation reports should be updated on a regular basis for reporting purposes. It is desirable to have 

independent valuations performed on the reporting date, e.g. 31 December 2008, or close to this date. What is to 

be considered close enough to a reporting date will depend on individual circumstances and a decision needs to 

be taken on a case by case basis. Where formal valuation reports have been issued at a significantly earlier date, 

management should consider requesting updates from the independent valuers. 

6.4 4BUWhat other considerations should management take into account in current market conditions? 

6.4.1 18BA 

key example of this scenario is to consider the impact on the ‘going concern’ assumption. Management may 

find themselves in a position where the going concern basis is clearly threatened by a property valuation 

outcome that is within the potential variability of the valuation figure. This would typically arise through lower 

valuation levels breaching loan-to-value covenants within a Group’s loan portfolio and therefore triggering 

repayments of the loan or at least additional cash deposit requirements with the relevant banks. Where this is the 

case, it is appropriate to conclude that the consequence of the valuation uncertainty on the presentation of the 

financial statements is significant, and therefore an emphasis of matter is required as a minimum in the audit 

report, and possibly consideration of adopting the break-up basis in extreme circumstances. 

6.4.2 19BManagement should review its funding in order to ensure that enough liquidity is available to the fund to 

continue as a going concern. Special attention should be paid to maturing credit facilities and lines of credit 

available from banks which themselves may have liquidity issues. Given the current economic climate 

management should also consider whether committed but uncalled capital is still available to the fund to 

overcome liquidity issues. 

6.4.3 20BA 

review of any commitments or contingent liabilities the fund might have, e.g. from sales of properties in prior 

years, which might trigger cash payments due to the current downturn in the economy, should be carried out. 

6.4.4 21BAny issued identified from the above should be considered in the preparation of the reporting of the fund. 

6.5 5BUHow may this impact the audit of financial statements of Luxembourg real estate funds? 

6.5.1 22BIn 

general, auditors will have to perform more work with respect to the uncertain elements of the valuation as 

described above such as the valuation of properties and the going concern assumption. Auditors will have to 

review and assess the appropriateness of the assumptions made by management and the reliability of the 

supporting documentation gathered to support their conclusions. 

6.5.2 23BAuditors may also consider modifications to their audit report in certain circumstances, including where in their 

judgement: 

• Assumptions and judgments made by management in valuing the properties are inaccurate or 

inappropriate; 

• Insufficient evidence exists, or has been considered, to reasonably value the properties; 

• Disclosures with respect to the uncertainty of the valuation of underlying funds are inadequate; 

• The valuer has qualified the valuation of the properties 

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• Disclosures with respect to covenant breaches are inadequate 

• There is doubt as to the ‘going concern’ basis of the fund; 

• Disclosures with respect to the ‘going concern’ basis of the fund are inadequate. 

• Assumptions and judgments made by management in respect of the ‘going concern’ basis of the fund are 

inaccurate or inappropriate. 

6.6 6BUWhat actions should be taken by the Central Administration / Custodian? 

6.6.1 24BCentral Administrators should work closely with the fund manager and fund’s Board to assess: 

• What values should be included in the accounts for the NAV calculation, if the independent valuation 

report includes a valuation uncertainty paragraph or a caveat to the valuation. The ultimate responsibility 

lies at Board level, who can ultimately decide whether or not to include impairment in the accounts. 

• What additional disclosures (if any) in the notes to the accounts of the financial statements are required. 

6.6.2 25BNo 

special actions need to be made by Custodians in relation with the above. The provisions of Chapter E of 

IML Circular 91/75 (the “Circular”) are still applicable and provide for the regulatory framework regarding all 

Luxembourg funds irrespective of their legal form or regime. According to the Circular, the custodian “has to 

have knowledge at any time on how the assets of the fund have been invested and where and how these assets 

are available”. The custody obligation has to be understood in the sense of supervision rather than safekeeping. 

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Real Estate fund matters - Alfi

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