Why the fuss over property?

Press, 3 October 1985, Page 26

Why the fuss over property?

By Stuart Foster, of Christchurch, national technical manager of Arthur Young, chartered accountants, and Roy Hasseldine, senior lecturer in accounting, University of Canterbury.

There has been much publicity recently over the problems in accounting for the income of property companies. The problems evolve from the different ways accountants view income compared with the way economists do. This difference largely arises because of the “real-

isation concept,” which has traditionally been an underlying principle of accounting. This means that transactions will not normally be recognised in the accounts unless they have actually taken place. Increases in property values are not the result of a completed transaction unless the property is actually sold, which produces a realised profit or loss. However, investment property companies are not usually in the business of trading in properties. They are often long-term investors which benefit through increases in property values. However, unless the property is sold, this increase is not a realised gain. Mr Bob Jones, chairman of Robt Jones Investments, Ltd, recently stated at their annual general meeting that the overwhelming golden

rule was “never sell.” Mr Jones said that over any reasonable period a permanent investor in property would always outperform the “hyperactive profit-tak-ing property trader.” Therefore, under traditional accounting, because the increase in property

values was not realised, the gain would not be included in the income statement.

The Society of Accountants has recognised this problem, and has produced an accounting standard which permits property investment companies to in-clude-the increase in values on property owned by them

in their income statement.

To calculate this change in values, the properties must be valued annually by *an independent registered valuer. This accounting standard caused much debate, but only applies to property investment companies, which are defined as having 80 per cent of their assets represented by invest-

ment properties. Property investment companies are reporting their profit with these unrealised gains, but the general market perception of these earnings is that the quality of such earnings isn’t high.

Perhaps part of the reason for the market’s reluctance to accept the quality of such profits is that investors may

have doubts as to whether these unrealised gains can be converted into cash dividends.

A company that makes a profit of, say, $5 million made up of unrealised gains may have more difficulty in making cash distributions than a trading company making the same profit. Cash and working capital are the lifeblood of any organisation and, without it, the company can fail. Of course, as property values increase the opportunity arises to borrow money against the increased value of that property.

The seems little consistency in the reported earnings of property companies analysed and commented on by the financial press. Some show the earnings without revaluations, while others include them. This lack of consistency by the financial press does not help the investor, and creates some confusion.

Mr Jones in his 1985 report stated that his company was considering dropping revaluations from the income statement because of the failure of

the market to distinguish between purported gains and actual results. Perhaps the situation will go the full circle, and result in companies not including the revaluation surplus. It would seem the question of what is the income of property companies has not been completely answered. Perhaps the market needs to be educated about the problems of realised and unrealised gains or losses. This whole question . goes beyond the accounting for property companies. Other transactions are included in the income statement which don’t meet the criteria of the “realisation concept.” Common examples include unrealised foreign exchange gains or losses, and bloodstock revaluations in some of the listed horse breeding companies. In any case, would the “real income” of the property companies please stand up! [The article was printed yesterday without attribution.]