Changes to public-sector asset valuations for financial reporting

In the past few years, public-sector bodies have become increasingly bogged down in the audit process at the end of the financial year, and indeed beyond.

This has led to delays in accounts being signed off and significant additional expenses, including the costs of the appointed auditor instructing another valuer to provide shadow valuations to test those of the body's own.

The working group included representatives from key stakeholders, including government departments, RICS, the Chartered Institute of Public Finance and Accountancy (CIPFA), the Valuation Office Agency, audit firms and many others.

The most consequential change that will impact valuers is that the HM Treasury Financial reporting manual (FreM) for 2025/26 has changed the requirement for public-sector bodies from commissioning annual to instead, quinquennial asset revaluations. 

This entails the indexation of valuations for the intervening four years or, alternatively, an annual rolling programme over a five-year cycle comprising the full valuation of a proportion with the annual indexation of the remainder.

For example, valuers must inspect and value 20% of an estate in one year but index the balance of 80% for that year. In each of the following four years, they will need to adopt a different 20% for inspection and valuation.

HM Treasury are not intending to be prescriptive regarding the means of indexation. However, the treasury application guidance available on the gov.uk website provides some guidance and examples.

FreM also includes a limited option to commission a desktop revaluation at year three, albeit only in exceptional circumstances where suitable indices are not available.

In addition, FreM sets out transitional arrangements for moving to the new process, meaning that the requirement to revalue at year five commences from the date of the last full revaluation. So, for example, if a body last commissioned a full revaluation on 31 March 2023, the requirement for the next full revaluation will be on the same date in 2028.

Other changes in the manual do not affect the role of the valuer. For example, the removal of specialised and non-specialised categories for accounting purposes does not obviate the requirement for valuers to make such a distinction under the current edition of RICS' Depreciated replacement cost method of valuation for financial reporting.

Although subject to much discussion, there is currently no restriction in FReM regarding modern equivalent asset (MEA) methodology for depreciated replacement cost (DRC) valued buildings.

However, a HM Treasury led working group is currently exploring considerations regarding the valuation of land associated with operational assets valued to DRC.

These considerations include potentially excluding alternative site and/or mandating the actual site area rather than a hypothetical smaller MEA site.

The move to International Financial Reporting Standard (IFRS) 16 from IAS 17 for leases mainly affects accountants and finance teams who classify the lease and also establish its value in accordance with the standard; the valuer has a limited role and is brought into play only as and when required.

The RICS practice statement sums this point up rather well: 'IFRS 16 is an accounting standard and as such is predominantly the domain of accountants and finance teams. However, it is beneficial if real estate professionals are aware of the high-level principles of IFRS 16 and where real estate expertise may be called upon.'

In summary, though, requirements are largely unchanged from International Accounting Standard (IAS) 17 so far as lessors are concerned. For lessees, however, IFRS 16 introduces the concept of right-of-use (ROU) assets. The valuation of such assets for financial reporting purposes represents the value of a lessee's right to use these for the lease term. 

The aim in valuing an IFRS 16 peppercorn lease – defined in FreM as those public-sector leases for which the consideration paid is nominal – or revaluing an ROU asset is to arrive at what would be payable were the lessee to be deprived of use of the lease and have to replace it with a similar asset under the same terms excepting passing rent, rent review date and existing rental concessions.

For lessees, a single accounting model also replaces the current 'finance lease' or 'operating lease' model. Public-sector-specific adaptations have been applied to the requirements of HM Treasury in its FReM regarding the application of IFRS 16 in the UK. 

For local authorities, CIPFA provides guidance to local authorities in their code, i.e. the local authority's equivalent of FReM.

Public-sector peppercorn leases are required to be assessed under IFRS 16 if they meet the definition of a lease in all aspects apart from containing a consideration.

Property leases with a term of more than 12 months must be recorded by the lessee on their balance sheet. So where an entity identifies an ROU asset, they may request its valuation having first considered whether the cost model or the revaluation model are appropriate.

Then, the valuer should decapitalise the freehold DRC figure to obtain a proxy DRC rental value for the building. They will subsequently recapitalise this proxy rent as at the valuation date for the remaining length of the non-cancellable lease term. This provides the capital valuation of the building.

Second, the valuer will establish the freehold value of the land, then decapitalise it to arrive at a proxy ROU asset land rent, as they did for the building.

The valuer will then likewise capitalise this proxy figure for the remaining length of the term certain. They will now have separate capitalised figures for the land rent and specialised building rent, which should be added together.

For lessees of ROU assets that are not specialised in nature, the valuer will arrive at the annual full market rent – the IFRS 16 market rent – and then capitalise for the non-cancellable term further to dialogue with the public-sector body.

Having implemented mandatory rotation in the private sector, however, RICS felt that the same provisions should be considered for the valuation of public-sector investment assets.

At the same time, it recognised that the situation and framework for such valuations is not as straightforward as in the private sector, given the mixture of in-house valuers as well as external firms involved.

In order to consider the issue, an RICS working group of subject matter experts was established, chaired by Nick French of Real Estate Valuation Theurgy. Group members, including valuers, accountants and auditors, were drawn from both the private and the public sector.

After rigorous discussion, the group felt that the valuation of investment assets for the private sector differs considerably from that for the public sector, as do the respective processes. The group considered that the valuation of such a public-sector asset is not one on which investors rely, and public debt is not attributed to any individual property. 

Furthermore, the rigorous procurement process required in the public sector ensures that there is often a rotation of internal or external valuers, and also between alternative external valuers.

Critically, public-sector asset valuations – including and especially investment assets – are subject to a detailed audit by external firms that usually employ their own professional valuers to test and assess such valuations. Auditors too are subject to rotation due to procurement requirements.

The group, therefore, decided that mandatory rotation is not necessary for the valuation of public-sector investment properties.