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French Investment Property Market and Property Values

Since 2001, the French real estate and property management industry had been growing steadily at an average rate of 2.8% per year, reaching a value of ?23.8 billion in 2004. Revenues from non-residential properties, including offices and warehouses, accounted for over a fifth of the industry?s valuei. France represented Europe?s third largest real estate management and development industry after the United Kingdom and Germany, generating 19.9% of the European industry?s value. The industry was forecast to grow by a further 3.7% per year by 2010ii. Other major publicly listed companies in the French real estate management and development industry included Gecina, Icade, Klpierre, Socit Foncire Lyonnaise and Unibail.

With 49 million m2 of office space, the Paris region represented the largest commercial real estate market in Europeiii. Since the 1980s, the commercial property market of Paris and its surrounding region had experienced substantial upward and downward movements in the values of properties (see Exhibit 7). By the end of 2004, the commercial property market appeared to be on the cusp of an upswing, with sales prices rising on the year by 1.5%iv.

EXHIBIT 7: Commercial Property Prices 1979?2003 in Paris and Surrounding Area (?/m2)

The graph represents the evolution of commercial property prices, measured in ?/m2, in central Paris, the La Dfense business area to the west of the city centre and in the Ile-de-France region surrounding Paris

Source: Banque de France/CB Richard Ellis Bourdaisvi

Accounting for Investment Properties in France

Prior to the introduction of IFRS accounting standards in France, Silic reported its property assets in accordance with the French General Accounting Plan at historical cost, being either the purchase cost for the properties it had acquired or the cost price of its new construction or redeveloped properties. The company depreciated its office and light industrial buildings on a straight-line basis over an average period of 40 years. Older buildings acquired were depreciated over a period taking into account their average age.

In 2003, Silic adopted SIIC status. Tile SIIC (Socits d?Investissements Immobiliers Cotes) tax regime was introduced by the French government in 2003 to create a strong and more efficient domestic real estate market. Inspired by the introduction of real estate investment trusts (REIT) in other countries, the SIIC legislation made real estate companies listed on the French stock exchange eligible for tax exemptions on their rental income and real estate capital gains, provided they distributed 85% of rental earning and 50% of capital gains to shareholders. Companies that elected the new regime had to pay a one-off ?exit tax? at a rate of 16.5% of latent capital gains on the buildings that they held.

EXHIBIT 8: Comments on Introduction of Fair-Value Accounting in France

Investment Property Industry

Serge Grybowski (CEO, Gecina)

Fair value is more indicative of the development of the property .market than the operational

performance of a real estate companyvii

Jean-Michel Gault (CFO, Klpierre)

Fair-value accounting complicates comparisons with historical accounting dataviii

European Public Real Estate Association

Fair-value accounting will enhance uniformity, comparability and transparency of financial reporting by real estate companies. It allows performance benchmarking with direct property market indices.

Real estate companies should therefore account for their property investments based upon the fair-value modelix.

International Accounting Firms and Associations

Rene Ricot (International Federation of Accountants)

Fair value is inevitable. Instability due to using market. values is a problem of the lack of education of market players and not that of accounting.

Franoise Bussac (Ernst & Young)

Fair value is the only single guideline to bring a real transparency in financial statements.

Financial Institution Investors

Federation of French Insurance Companies

Accounts reported at fair value can be deceptive and risk injecting a large dose of subjectivity into financial statements.

Sylvie Mathrat (General Secretary of the French Banking Commission)

The main problem of fair-value accounting is the volatility of earnings

Financial Analysts

Association of French Financial Analysts

The use of fair value can confuse interpretation of a company?s operational results. Fair-value accounting is less reliable, allows greater manipulation of results and introduces volatility.

National Financial Authorities

French National Accounting Council (CNC)

The CNC endorsed neither historical-cost nor fair-value accounting since both methods were authorized under IAS 40.

French financial market regulator (AMF)

Fair-value accounting prevents the manipulation of results by managers by going in and out of the market to make the appearance of results at their will. However, it is better to avoid rushing through too audacious accounting reforms in a period of instability of markets.

Source: Compiled by case writerx

Having chosen to adopt the new SIIC status, Silic followed the recommendations of the French accounting standards body (Conseil National de la Comptabilit) and financial market regulator (Autorit des Marchs Financiers) and had its buildings and land revalued by two independent external appraisers on an open-market and building-by-building basis. This one-off, fair-value revaluation had a significant impact on Silic?s 2003 balance sheet. Indeed, the value of the company?s investment properties and land increased from 2002 to 2003 by over ?600 million or 70%.

Adoption of International Accounting Standards

The adoption of IFRS in January 2005 would have a number of effects on European property investment companies such as Silic. One major reporting issue related specifically to the International Accounting Standard 40 (IAS 40, Investment Properties). This standard allowed companies to report their investment properties using either a historical-cost model or a fair-value model.

Under the historical-cost model, investment property would be reported on the balance sheet at cost less accumulated depreciation and any impairment losses. Any changes in fair value would have to be evaluated by external appraisers and reported in the footnotes of annual reports. Companies that initially adopted the historical-cost model could switch to the fair-value model at a later date, if this would result in a more appropriate presentation of financial results.

Under the fair-value model, investment property (but not investment properties under construction or building land) would be revalued and reported on the balance sheet at its current market value, with all changes in value reported in the income statement. IAS 40 defined fair value as the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm?s-length transaction. Under the terms of IAS 40, companies adopting the fair-value method could not switch to the historical-cost method.

Although widely used outside of France, the concept of fair-value accounting was by and large unknown to the French. It called into question the country?s long-established accounting traditions based on the principles of prudence and an avoidance of a valuation of assets which could lead to the disclosure of overvalued assets in financial statementsv. The implementation of IFRS accounting standards triggered a lively public debate about the strengths and weaknesses of fair-value accounting versus historical-cost accounting (see Exhibt 8).

In the face of the implementation of IFRS, Dominique Schlissinger noted that Silic faced important cultural, sectoral and strategic dilemmas. It was against this background that the company?s Board of Directors met on this issue on numerous occasions during 2003 and 2004 to better understand IAS 40. How would the two distinctive accounting models impact on Silic?s financial statements? Which method would most transparently reflect Silic?s real value? In short, which method should Silic ultimately adopt on January 1, 2005? (Anthony 215-217)

Anthony, Robert Hawkins, David Merchant, Kenneth A.. Accounting: Texts and Cases, 13th Edition. McGraw-Hill Learning Solutions, 40910. VitalBook file.

The citation provided is a guideline. Please check each citation for accuracy before use.

French Investment Property Market and Property Values Since 2001, the French real estate and property management industry had been growing steadily at an average rate of 2.8% per year, reaching a value of 23.8 billion in 2004. Revenues from non-residential properties, including offices and warehouses, accounted for over a fifth of the industry's valuei. France represented Europe's third largest real estate management and development industry after the United Kingdom and Germany, generating 19.9% of the European industry's value. The industry was forecast to grow by a further 3.7% per year by 2010ii. Other major publicly listed companies in the French real estate management and development industry included Gecina, Icade, Klpierre, Socit Foncire Lyonnaise and Unibail. With 49 million m2 of office space, the Paris region represented the largest commercial real estate market in Europeiii. Since the 1980s, the commercial property market of Paris and its surrounding region had experienced substantial upward and downward movements in the values of properties (see Exhibit 7). By the end of 2004, the commercial property market appeared to be on the cusp of an upswing, with sales prices rising on the year by 1.5%iv. EXHIBIT 7: Commercial Property Prices 1979-2003 in Paris and Surrounding Area (/m2) The graph represents the evolution of commercial property prices, measured in /m2, in central Paris, the La Dfense business area to the west of the city centre and in the Ile-de-France region surrounding Paris Source: Banque de France/CB Richard Ellis Bourdaisvi Accounting for Investment Properties in France Prior to the introduction of IFRS accounting standards in France, Silic reported its property assets in accordance with the French General Accounting Plan at historical cost, being either the purchase cost for the properties it had acquired or the cost price of its new construction or redeveloped properties. The company depreciated its office and light industrial buildings on a straight-line basis over an average period of 40 years. Older buildings acquired were depreciated over a period taking into account their average age. In 2003, Silic adopted SIIC status. Tile SIIC (Socits d'Investissements Immobiliers Cotes) tax regime was introduced by the French government in 2003 to create a strong and more efficient domestic real estate market. Inspired by the introduction of real estate investment trusts (REIT) in other countries, the SIIC legislation made real estate companies listed on the French stock exchange eligible for tax exemptions on their rental income and real estate capital gains, provided they distributed 85% of rental earning and 50% of capital gains to shareholders. Companies that elected the new regime had to pay a one-off 'exit tax' at a rate of 16.5% of latent capital gains on the buildings that they held. EXHIBIT 8: Comments on Introduction of Fair-Value Accounting in France Investment Property Industry Serge Grybowski (CEO, Gecina) Fair value is more indicative of the development of the property .market than the operational performance of a real estate companyvii Jean-Michel Gault (CFO, Klpierre) Fair-value accounting complicates comparisons with historical accounting dataviii European Public Real Estate Association Fair-value accounting will enhance uniformity, comparability and transparency of financial reporting by real estate companies. It allows performance benchmarking with direct property market indices. Real estate companies should therefore account for their property investments based upon the fair-value modelix. International Accounting Firms and Associations Rene Ricot (International Federation of Accountants) Fair value is inevitable. Instability due to using market. values is a problem of the lack of education of market players and not that of accounting. Franoise Bussac (Ernst & Young) Fair value is the only single guideline to bring a real transparency in financial statements. Financial Institution Investors Federation of French Insurance Companies Accounts reported at fair value can be deceptive and risk injecting a large dose of subjectivity into financial statements. Sylvie Mathrat (General Secretary of the French Banking Commission) The main problem of fair-value accounting is the volatility of earnings Financial Analysts Association of French Financial Analysts The use of fair value can confuse interpretation of a company's operational results. Fair-value accounting is less reliable, allows greater manipulation of results and introduces volatility. National Financial Authorities French National Accounting Council (CNC) The CNC endorsed neither historical-cost nor fair-value accounting since both methods were authorized under IAS 40. French financial market regulator (AMF) Fair-value accounting prevents the manipulation of results by managers by going in and out of the market to make the appearance of results at their will. However, it is better to avoid rushing through too audacious accounting reforms in a period of instability of markets. Source: Compiled by case writerx Having chosen to adopt the new SIIC status, Silic followed the recommendations of the French accounting standards body (Conseil National de la Comptabilit) and financial market regulator (Autorit des Marchs Financiers) and had its buildings and land revalued by two independent external appraisers on an open-market and building-bybuilding basis. This one-off, fair-value revaluation had a significant impact on Silic's 2003 balance sheet. Indeed, the value of the company's investment properties and land increased from 2002 to 2003 by over 600 million or 70%. Adoption of International Accounting Standards The adoption of IFRS in January 2005 would have a number of effects on European property investment companies such as Silic. One major reporting issue related specifically to the International Accounting Standard 40 (IAS 40, Investment Properties). This standard allowed companies to report their investment properties using either a historical-cost model or a fair-value model. Under the historical-cost model, investment property would be reported on the balance sheet at cost less accumulated depreciation and any impairment losses. Any changes in fair value would have to be evaluated by external appraisers and reported in the footnotes of annual reports. Companies that initially adopted the historical-cost model could switch to the fair-value model at a later date, if this would result in a more appropriate presentation of financial results. Under the fair-value model, investment property (but not investment properties under construction or building land) would be revalued and reported on the balance sheet at its current market value, with all changes in value reported in the income statement. IAS 40 defined fair value as the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm's-length transaction. Under the terms of IAS 40, companies adopting the fair-value method could not switch to the historical-cost method. Although widely used outside of France, the concept of fair-value accounting was by and large unknown to the French. It called into question the country's long-established accounting traditions based on the principles of prudence and an avoidance of a valuation of assets which could lead to the disclosure of overvalued assets in financial statementsv. The implementation of IFRS accounting standards triggered a lively public debate about the strengths and weaknesses of fair-value accounting versus historical-cost accounting (see Exhibt 8). In the face of the implementation of IFRS, Dominique Schlissinger noted that Silic faced important cultural, sectoral and strategic dilemmas. It was against this background that the company's Board of Directors met on this issue on numerous occasions during 2003 and 2004 to better understand IAS 40. How would the two distinctive accounting models impact on Silic's financial statements? Which method would most transparently reflect Silic's real value? In short, which method should Silic ultimately adopt on January 1, 2005? (Anthony 215-217) Anthony, Robert Hawkins, David Merchant, Kenneth A.. Accounting: Texts and Cases, 13th Edition. McGraw-Hill Learning Solutions, 40910. VitalBook file. The citation provided is a guideline. Please check each citation for accuracy before use