What’s it: An investment property is a company’s long-term investment in the property sector to obtain a rental income or capital appreciation. It can be an investment in the land and buildings. The company recognizes it as an asset if there are economic benefits that flow to the company in the future, and if the company can measure the cost reliably.
It excludes property to support production activities, provide goods and services, or support administrative activities. Held-for-sale property in the normal business course is also excluded in the investment property category.
Investment property differs from property, plant, and equipment (PP&E). Although they both represent the company’s non-current assets, they are presented separately because the latter is used in the entity’s business activities.
Types of property investment
Broadly speaking, two types of property classes are residential property and commercial property.
- Residential property in the form of a residence such as a condominium, apartment, or landed house.
- Residential property includes property for business purposes, not residence. Examples are retail space, industrial land, and office space.
Why invest in property
Advantages of property investment
Property can be an alternative asset class to stocks, bonds, or mutual funds. Investing in property is a good idea if the company is in it for the long term, not for quick profits. The advantages of investing in property are:
- Offers predictable cash flow through rental income
- Potential profit from price appreciation.
- Companies could take advantage of various tax breaks to reduce the fair costs of managing the property.
Disadvantages of property investment
Investing in property also comes with several risks:
- Investments require a more significant down payment than other asset classes
- The legal requirements are more complex. So, the related legal costs will also be higher
- Rental property investments are also vulnerable to changes in the property market
- Rental income depends on the ability to keep renting them out.
- Transaction costs are much higher, which can significantly affect the investment’s value and make it more challenging to make a profit. So investment returns will not occur immediately.
- The market is less liquid than the stock market or bond market.
How the company presents it in financial statements
Under IFRS, the company can use a cost model or a fair value model to report investment properties in financial statements
Capital cost – It is similar to a cost model for measuring PP&E. Under this model, a company estimates investment property at cost less accumulated depreciation and any accumulated impairment losses.
Fair value model – a company can use this model only if it can reliably determine the property’s fair value on an ongoing basis. All changes in the fair value of assets impact net income. The company valuate property at the end of each reporting period and presents the changes in fair value in the income statement as they occur.