The adoption of the International Financial Reporting Standards (IFRS) rather than German GAAP can bring benefits to German real estate companies even today. To this end, it is not necessary to first endorse the IFRS for companies not legally required to apply IFRS (‘IFRS-SME’) into German law.

Importance of IFRS permanently increasing

The internationalisation of the economy requires an internationally uniform accounting system to allow a better comparability of the financial statements. Currently, the IFRS are applied in more than 100 countries and recognised by the New York Securities and Exchange Commission (SEC).

In accordance with the IAS Directive, the preparation of consolidated financial statements according to IFRS has been binding for all enterprises whose securities are admitted to trading on regulated market (‘listed’) in Europe since 2005. These consolidated financial statements permit an exemption from the duty to prepare consolidated financial statements according to German GAAP. But also companies not legally required to apply IFRS might be required to prepare financial statements according to IFRS if they are affiliated to a group which uses IFRS accounting.

In addition to this legal requirement there are de-facto obligations to prepare an IFRS reporting, in particular if it is intended to attract foreign investors. As the real estate location Germany is becoming increasingly attractive to international investors with respect to transaction volumes (in Q 4/2010 approximately 40 % according to a DTZ analysis), we assume that also the number of enterprises required to prepare IFRS reports will rise.

Fair value approach nowadays common

In contrast to the accounting policies under German GAAP it is possible according to IFRS to use the fair value approach for investment properties. Investment properties are held to earn rentals or for capital appreciation or both.

In the current lending practice fair values play an important role, as banks take the fair value into account both for lending and for the ongoing monitoring of loans. Generally, loan agreements include a number of covenants, which in case of default are sanctioned by (partial) repayment obligations. The loan-to-value ratio is often taken as a basis here, which compares the financing of a property to the determined value of the same property. The fair value to be determined by a valuation surveyor is the value on which this comparison is based. An increasing market value of the real estate in relation to the loan volume in general leads to lower refinancing cost.

The valuation of real estate or property companies using the fair value has been common anyway for quite some time now, so that this type of accounting should actually suit the requirements of the real estate sector. In particular, internal risk management could be adjusted to external reporting. The integration of external and internal accounting would therefore be possible with minimal effort.

IFRS improve opportunities in the capital market

Beyond question, the introduction and continuous adoption of IFRS are a major challenge in terms of organisation and personnel, as these standards are different from German GAAP in various aspects. In particular the continuous valuation of the real properties at fair values represents a challenge, as the fair value determination has to be transparent. For this purpose a company has to communicate the assumptions made in the process of property valuation. Furthermore, these assumptions have to be integrated in the objectives of asset and property management. The change of certain interest development assumptions alone may have a significant influence on the fair value and therefore have direct effect on the results of operation and the net assets position. The same applies in situation where management costs are optimised in the context of active asset management.

The benefit of adopting IFRS is the opportunity to address a wider (international) capital market. Not only will the number of potential investors increase as a result, but it will also be easier to gain internationally operating banks as financers. Ideally, this might lead to a reduction of interest to be paid (for loans) – this is an effect which will compensate for the cost of implementing IFRS.

IFRS-SME would mean a relief

In July 2009, the International Accounting Standards Board (IASB), which sets forth the conditions for accounting according to IFRS, issued a standard for ‘small and medium-sized entities’ (IFRS-SME). IASB estimates the percentage of such enterprises to account for 95 % of all enterprises. Therefore, this standard might become extremely important, even though it has not yet been endorsed in Germany.
Particularly real estate companies, which have already adopted IFRS reporting, would benefit from the relief if they could report exclusively according to IFRS instead of using German GAAP. As a prerequisite, however, the IFRS standards have to be established as a full-fledged alternative to accounting according to German GAAP. Should German legislature finally decide in favour of it, many real estate companies could save costs for preparing financial statements according to German GAAP.

Particularly in Germany many market participants are against a binding adoption of the IFRS-SME regulations, arguing that the IFRS were too complex and that the modernisation of the German commercial law presented an alternative. An additional argument used is that the IFRS had contributed to an aggravation of the crisis on the financial markets, as fair value accounting led to a volatile result.

Conclusion

The IFRS certainly have their advantages for real estate companies. With their adoption internal corporate controlling corresponds to external accounting, and therefore both the risk appetite and risk management of a company become transparent. The fact that a wider, also international capital market is addressed can help enterprises to reduce their financing costs and hence increase their equity value, too.
Furthermore, the IFRS are internationally recognised and continued to be accepted despite all criticism. Nonetheless, the conversion of accounting to IFRS entails costs, which, on the other hand, are offset by partially significant cost savings. Whether accounting according to IFRS is reasonable can only be decided on a case-by-case basis for each enterprise.

At the moment, there are predominantly legal reasons against the adoption of the IFRS-SME in Germany, as legislature refused to establish the IFRS as an alternative to German GAAP. If IFRS-compliant consolidated financial statements had an exempting effect, at least companies with IFRS reporting for the consolidated accounts would be relieved significantly without a duty to prepare accounts according to German GAAP.