14. Investment Properties
|12 Months Ended|
Dec. 31, 2017
Note 14 — Investment Properties
Investment properties were valued on December 31, 2017, 2016 and 2015 using the discounted cash flow (DCF) method by an independent qualified professional valuation expert. The methods and assumptions adopted for the real estate appraisals carried out by the expert in determining the fair value of the investment property are in accordance with IAS 40, Investment Property.
The Group currently has no obligations to purchase, construct new investment properties or develop the existing investment properties.
Investment properties valuation at December 31, 2017, 2016 and 2015 are shown in the table below:
Details of the investment properties is as follows:
At December 31, 2017, 2016 and 2015, all investment properties are in the commercial rental category.
The overall reduction of the portfolio’s fair value from 2015 to 2016 mainly reflects the 2.83% decrease in the 2016 year-end Euro currency exchange rate, compared to the US Dollar from the prior year. The Euro currency exchange rate from 2016 to 2017 reflects an increase of 13.93%. The significant decrease in the 2017 fair value of the total commercial rental properties from 2016 is primarily due to (1) the sale of Nova in November 2017 (Nova’s sole asset consisted of the property located at Corso Europa 22, Milan, Italy) and (2) the adjustment to the fair value to the property on Via Buozzi 22 as a result of the Company entering into a contract subsequent to year end offering an unrelated party to purchase the property in February 2018. This contract expires on December 31, 2018 (see note 30 — Subsequent Events).
The portfolio of properties has low vacancy rates. The properties have an average lease expiration of approximately 5 years. The properties comprising the portfolio are commercial real estate assets.
During 2015, the economic recession in Italy continued to affect the real estate industry causing a general delay in rental payments and sometimes an early termination of outstanding leasing agreements. Nevertheless, the amount of rental fees is essentially unchanged compared to previous years. During 2017 and 2016, the general economy in Italy has improved, compared to 2015. The largest improvement in the real estate sector in Milan was in the residential assets. The market for retail offices in Milan, unlike the residential sector, is struggling to recover fully, although the improvement of some indicators seems to confirm the conditions for a recovery. The market for shops in 2017 confirms the growth trend started in 2014. The warehouses/laboratories market still appears to be weak in 2017, with a demand that is still inadequate to absorb the oversupply.
Under the DCF method, a property’s fair value is estimated using explicit assumptions regarding the benefits and liabilities of ownership over the asset’s life including an exit or terminal value. As an accepted method within the income approach to valuation, the DCF method involves the projection of a series of cash flows on real property interest. To this projected cash flow series, an appropriate, market-derived discount rate is applied to establish the present value of the cash inflows associated with the real property.
The duration of the cash flow and the specific timing of inflows and outflows are determined by events such as rent reviews, lease renewal and related lease up periods, re-letting, redevelopment, or refurbishment. The appropriate duration is typically driven by market behavior that is a characteristic of the class of real property.
In the case of investment properties, periodic cash flow is typically estimated as gross income less vacancy, non-recoverable expenses, collection losses, lease incentives, maintenance cost, extraordinary maintenance cost, agent and commission costs and other operating and management expenses. The series of periodic net cash inflows, along with an estimate of the terminal value anticipated at the end of the projection period, is then discounted.
In regards to the commercial rental properties in the town of Assago, Buccinasco and Rozzano, the market data of the outskirt area of Milan was used as a basis of comparison. For the commercial rental property at Corso Europa 22 in Milan, it is considered to be in the top range category due to the location of the property and the current rental agreements in place. The Corso Europa 22 property has been sold with Nova in November 2017, hence no longer in the Company’s portfolio.
The Group has set up a policy of engaging an independent qualified professional valuation expert to value the investment properties on an annual basis at the end of each year. Selection criteria include market knowledge, reputation, independence and whether professional standards are maintained. The valuation performed by the independent qualified professional valuation expert is reviewed by the Group’s Interim CEO, Interim CFO, and certain members of the Board of Directors.
The summary of the unobservable inputs used for the year ended December 31, 2017 are as follows:
The summary of the unobservable inputs used for the year ended December 31, 2016 are as follows:
The summary of the unobservable inputs used for the year ended December 31, 2015 are as follows:
Descriptions and definitions
Estimated rental value (ERV)
The rent at which space could be leased in the market conditions prevailing at the date of valuation or the actual rental income of the property, whichever is higher.
Rental growth p.a. (per annum)
The estimated average increase in rent based on both market estimations and contractual indexations.
Rate used to discount the net cash flows generated from rental activities during the period of analysis (estimated up to 10 years).
Gross capitalization rate (Cap rate)
Rate used to estimate the value that the property will be sold at the end of the rental period by capitalizing the final year’s gross income at an appropriate market gross capitalization rate based on the ERV of the property.
Sensitivity analysis to significant changes in unobservable inputs within Level 3 of the hierarchy
The significant unobservable inputs used in the fair value measurement categorized within Level 3 of the fair value hierarchy of the entity’s portfolios of investment property are:
Significant increases (decreases) in the ERV and rental growth p.a. in isolation would result in a significantly higher (lower) fair value measurement. Significant increases (decreases) in the discount rate and gross capitalization rate in isolation would result in a significantly lower (higher) fair value measurement.
Generally, a change in the assumption made for the ERV is accompanied by a similar change in the rent growth p.a., discount rate, and gross capitalization rate.
The entire disclosure for investment property.
Reference 1: http://www.xbrl.org/2003/role/disclosureRef