Copyright: David Lawson– Property Week March 1999Home page
Accounting changes in the pipeline could push property companies over the brink to the kind of cashflow valuations increasingly being demanded by financiers by the year 2000. Some property companies could face severe problems when new rules come into force next March, says JC Rathbone, a financial consultant which has advised around half the quoted investment companies in the sector.
They will expose the true cost of hedging and borrowing through swaps, debentures, convertibles, bonds warrants and a range of derivatives. They will need to be assessed to 'fair value', which must then be stated in notes to annual accounts. Companies must recognise the effects of changes in interest and currency rates on their financial assets and liabilities, says Rathbone. This could affect the calculation of net worth.
Real values are often hidden or undeclared by firms which merely state the book or original cost of borrowing. FRS 13, a guide set by the Accounting Standards Board, moves the UK closer to international rules by insisting that inherent risks are disclosed.
'This standard shines a torch into a darkened room,' says Sir David Tweedie, chairman of the ASB. 'Many companies use types of financial instrument that can transform the business's risk profile overnight, yet under previous practice could be hidden from view.
A hedge instrument, for instance, might be showing a large loss because of adverse interest rate changes, yet would not be shown in the accounts until it matured.
JC Rathbone says the effect on quoted property companies will be considerable. Net asset value, the established benchmark for measuring worth, will be pushed aside as analysts factor in risks exposed by the new rules. 'It could be the biggest single event which will move the property sector to cashflow valuations,' says Rathbone.
The consultant criticises some estimates that have already been attempted, pointing out that they use termination rather than replacement costs, which can often be higher.
Every quoted property company will be affected because it will focus attention on the way they manage risk and assess how they would fare during interest and currency rates. But private companies may also be drawn into the web, as banks could demand similar assessments of risk in loan applications.