Investment property and owner-occupied property are two common types of real estate assets. The key difference lies in the purpose of holding the property. Investment property refers to property held mainly to earn rental income or for capital appreciation. In contrast, owner-occupied property is held by the owner for use in production, supply of goods/services or administrative purposes. Under accounting standards like IFRS and US GAAP, the valuation and accounting treatment differ for the two types of properties. This article will focus on the key differences and valuation methods for owner occupied investment properties.
The criteria for distinguishing between investment property and owner-occupied property
The distinction between investment property and owner-occupied property is not always clear cut. Some properties may have dual usage with a portion held for rental income and another portion for owner’s use. Accounting standards provide guidance on how to classify such dual-use properties. In general, if the portion held for owner’s use is insignificant relative to the total property, the entire property can still be classified as investment property. However, if the owner-occupied portion is significant and can be sold or leased out separately, then separate accounting is required for the different portions.
The accounting treatment and valuation methods
For investment properties, companies have a choice between fair value model and cost model for subsequent measurement. The fair value model is more commonly adopted and involves reporting investment properties at fair market values on the balance sheet with changes in fair value flowing through profit and loss. For owner-occupied properties, the cost model is used with depreciation and impairment testing. When an owner-occupied property becomes an investment property, it needs to be revalued to fair value. Any gains over historical cost are recognized in other comprehensive income to the extent of reversing previous impairment losses and depreciation. Any further gains are reported in profit and loss.
Impairment considerations for owner-occupied properties
Owner-occupied properties are subject to impairment testing when there are indicators of impairment. Common indicators include declining market values, change in business strategy and poor physical condition of the property. If the recoverable amount, based on either fair value or value in use, is below carrying cost, then impairment loss needs to be recognized. For investment properties carried at fair value, impairment is already reflected in the periodic revaluations.
Disclosure requirements
For investment properties, companies have to disclose the valuation methods and key assumptions used in determining fair values, which are usually performed by external valuers. The amounts of rental income and direct operating expenses need to be disclosed separately as well. For owner-occupied properties, the disclosures include the depreciation methods, useful lives and impairment losses recognized.
Other considerations
When classifying properties, companies also need to look out for sale and leaseback transactions which could alter the original classification. The accounting for investment properties held in joint ventures and associates also requires special consideration under the equity method of accounting.
In summary, the key difference between investment properties and owner-occupied properties lies in the purpose for holding the properties. This drives the different accounting treatment especially in terms of valuation methods. Proper classification and accounting is important to reflect the performance and financial position of real estate companies appropriately.