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Valuing Investment Property under Construction - EPRA

Valuing Investment Property under Construction - EPRA

We have called this a

We have called this a ‘mark to model’ approach and, as the name suggests, itnecessitates the use of a valuation model. It is the principles behind such models thatare the focus of this recommendation.Project gainsThe gain associated with realising a project, and discussed in this paper, comprises thefull gain that will accrue to the developer from the initial planning consent until theproperty is complete. In certain jurisdictions, development activities are separated fromasset management and investment property activities - typically a developmentcompany develops the property, and on completion transfers it to the investmentcompany to manage. An issue that might then arise is which part of the gain isattributable to the development company - for example a substantial part of the projectgain is due to the letting process, and that might be said to be either an assetmanagement activity or a development activity. Although important, this paper does notattempt to distinguish between the two and assumes the development takes place inone single entity or from a consolidated perspective.Moreover, an increase in value of a project over time may be the result of a wholevariety of reasons, including but not limited to development activities, macro and microeconomic circumstances, occupier fundamentals and changes in the capital markets.Therefore, even if a project has increased in value over time it will not be possible toisolate the gain realised from development activities from the other factors referred toabove.Project lossesIn some circumstances the development process may not realise a project gain. Projectvalues may decrease during the development process due to (i) economiccircumstances, changes in market conditions or changes in occupier fundamentalsreducing the projected value of the completed property and/or (ii) development costsexceeding budgets/forecasts.The principles set out below assume that a project gain will be achieved. Situationswhere project losses arise have not been dealt with in this paper.Redevelopment projectsFinally, we note that the principles outlined below would also be applicable to valuingexisting investment property undergoing major refurbishment.The principlesAt the recent EPRA meeting in Stockholm, held on September 03, 2008, a series of 14principles were presented to a roundtable of representatives from the real estate2November 2008 - Valuing Investment Property under Construction

industry including European listed property companies, investors, advisors andappraisers.The principles that were agreed in that meeting are listed below:1. The starting point of any valuation of IPUC should be a completed property. Such avaluation should be based on current valuations applicable to similar existingcompleted properties with comparable encumbrances to property rights. In practice,property is not usually fully let on completion, but an appraiser will still be able tovalue the IPUC and should normally be able to demonstrate possible scenarios.2. The gain which may be attributable to realising project objectives is the differencebetween the value of a completed building and its construction costs - including thecost of the land, finance costs incurred during construction and any directlyattributable costs.3. Project risks are all risks associated with realising the project objectives. Theexistence of unmitigated project risks is a key factor in arriving at the fair value ofIPUC. The significant project risks associated with the development should beidentified.4. When project risks are minimised or eliminated, a degree of project gain may havebeen achieved and the value of the project increased. However, project gain shouldonly be recognised in a valuation of an IPUC when a substantial amount of theproject risks have been reduced or eliminated. An appraiser should disclose thesignificant judgements used in determining the stage at which a substantial amountof the project’s risks have been eliminated (see also 7 below).5. The above notwithstanding, if the land has increased in value - perhaps via the issueof government permits - and comparable prices exist for land in that condition in anactive market, then that part of the project gain should be recognised.6. Valuations should be based on project cash inflows and outflows, taking into accountthe time value of money and remaining project risks. The cash outflows must includeall construction and other project costs still to come, based on contracted terms andcurrent best estimates.7. Transparency of the valuation estimate is important. The appraiser should include adescription of their valuation methodology and the key assumptions used in theirreport to the client. In particular, the appraiser must also identify how the remainingrisks of the project have been dealt with in the valuation - any contingent element,deductions or risk adjusted discount rates should be quantified and explained withreference to the remaining project risks.We have included in Appendix I the rationale for these agreed principles. A number ofother principles were not adopted during the meeting and these are listed in Appendix II.The attendees at the meeting are listed in Appendix III.3November 2008 - Valuing Investment Property under Construction

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