The market discount of property developers’ shares and accounting policies
| Pages | 172-193 |
| DOI | https://doi.org/10.1108/JPIF-08-2018-0056 |
| Date | 11 February 2019 |
| Published date | 11 February 2019 |
| Author | Chee Kwong Lau,Li Li Wong |
| Subject Matter | Real estate & property,Property management & built environment |
The market discount of
property developers’shares
and accounting policies
Chee Kwong Lau
University of Nottingham, Semenyih, Malaysia, and
Li Li Wong
Brunsfield Project Management Sdn Bhd, Kuala Lumpur, Malaysia
Abstract
Purpose –The purpose of this paper is to answer the fundamental question about why the shares of
property developers are traded at market discounts by focusing on property developers from Hong Kong,
Malaysia and Singapore.
Design/methodology/approach –It measures market discount using market-to-book ratio (MTB) and
specifies the relations between MTB and the hypothetical determining factors (revenue recognition policy,
investment property measurement policy, related party (RP) transaction disclosures and economic rent) in the
presence of relevant control variables.
Findings –This study finds that aggressive revenue recognition and investment property measurement
policies increase market discounts, but that RP transactions generally contribute positively to reduce the
market discounts of property developer shares. Specifically, RP transactions are value-enhancing only if
property developers adopt a conservative revenue recognition policy, because markets sensibly see RP
transactions that are part of an aggressive revenue recognition policy as earnings management for tunnelling
by controlling shareholders, and hence react with discounts. It is also observedthat when property developers
generate insufficient profit to cover their cost of equity, this generally leads to their shares being traded at
market discounts. However, an aggressive revenue recognition policy can reduce market discount if early
recognition contributes positively to economic rent.
Practical implications –This study provides valu able evidence of the econ omic consequences
(market discounts) of accounting choices on recognition and measu rement, and the disclosure of a ccounting
information. This is cr ucial to managers of prope rty developers in managi ng their firm values when
exercising accounting discretion.
Originality/value –This study provides empirical evidence on market discounts as they relate to property
developers, which has been limited (past studies focus on property investment companies and real estate
investment trusts).
Keywords Revenue recognition, Property developer, Economic rent, Market discount
Paper type Research paper
1. Introduction
It has been pervasively documented that property companies’shares are usually traded
below their net asset values (NAV) –in other words, at a market discount. Examples of this
phenomenon include the UK (Barkham and Ward, 1999; Eccles et al., 2005; Ke, 2015),
Europe (Nellessen and Zuelch, 2011; Morri and Baccarin, 2016), Hong Kong, Singapore and
Malaysia (Liow, 2003; Lau, 2013; Downs et al., 2016). The fundamental question is: why does
the market discount the NAV of these property companies?
Adams and Venmore-Rowland (1990) suggest that it makes sense for the value of a
property company to be driven primarily by the value of its properties but less by its
earnings or cash flows. However, Liow (2010) finds that increases in real estate prices may
not be fully reflected in the stock prices of property companies. Barkham and Ward (1999)
conclude that capital gains tax liabilities, the degree of market confidence in management,
firm size and the level of trading stock are factors that can cause market discounts on
property investments and property closed end funds. Nellessen and Zuelch (2011) find that
deviations in the NAV from the market capitalisation of a sample of European property
Journal of Property Investment &
Finance
Vol. 37 No. 2, 2019
pp. 172-193
© Emerald PublishingLimited
1463-578X
DOI 10.1108/JPIF-08-2018-0056
Received 10 August 2018
Revised 21 October 2018
20 December 2018
Accepted 20 December 2018
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1463-578X.htm
172
JPIF
37,2
companies are a consequence of a lack of reliability of fair value estimates for investment
properties in their balance sheets. Downs et al. (2016) provide evidence that is related to
party acquisitions from sponsors to REITs generally drive value, although this impact can
be reversed in a credit crisis. Finally, Ooi and Liow (2002) conclude that Singapore real
estate companies perform poorly in terms of their economic profit, and are hence not able to
add value to shareholders’wealth.
We attempt to answer this fundamental question and add to the existing literature by
focusing on property developers in Hong Kong, Malaysia and Singapore. We conjecture
that property developers have more than only properties on th eir books when the y
undertake economic activities and create wealth for shareholders. At the same time, we
seek to differentiate property developers from property investment companies
(which focus more on property investment, services and trading) and REITs
(which focus only on property investment). Property developers create value mainly
from property development activities, while the other types of companies create value
mainly from investment income –rental, capital appreciation and other related property
services[1]. We demonstrate this differentiation through a preliminary analysis of the
financial statements of some property developers and other property companies
(including REITs) in Hong Kong, Malaysia and Singapore. The results of this are
presented in Table I.
While we acknowledge that there is some overlap in business activities between property
developers, property investment companies and REITs, there are also some identifiable
fundamental differences between them. Some property developers, especially in developed
markets where property development activities have been rather saturated, tend to diversify
into property investment and related services, while keeping property development as their
core business. Property developers tend to have a major portion of their assets in “land held
under development”,“development costs”and “completed property held for trading
(inventories)”. They normally also have a smaller amount of their assets in investment
properties than under development (for instance, see China Evergrande, SP Setia and
City Development, as presented in Table I).
In contrast, property investment companies have their core business in property
investment, although they may also be involved in some limited property development
activities, mainly intended to support their property investment business. For instance,
Sun Hung Kai and Great Eagle held 51.8 and 68.7 per cent, respectively, of their total assets
as investment properties, while assets under development and developed property made up
a relatively smaller portion of their total assets. REITs are a more clear-cut case, with their
only business being property investment and related services; and the overwhelming
bulk of their assets therefore being made up of investment properties (ranging from 93.3 to
97.7 per cent in the six REITs presented in Table I).
We explore three hypothetical determinants, based on accounting policies and
disclosures, for the phenomenon of property developers’shares being traded at a market
discount over their NAV. Fundamentally, the NAV is the aggregated accounting value of a
firm as a consequence of recognition and measurement of its assets and liabilities, based on
accounting principles as prescribed in financial reporting standards[2].
First, property developers may use relatively more aggressive revenue recognition policy
and book their revenue and earnings (and hence the corresponding assets) early, i.e. based
on the stage of completion (see Eccles et al., 2005; Lau, 2013). Second, property developers
may also mark their investment properties to the market value, thereby booking an
unrealised fair value gain and inflating the value of assets (see Quagli and Avallone, 2010;
Nellessen and Zuelch, 2011). These first two determinants (revenue recognition and
investment property measurement policies) hypothesise that the market discount could be
due to an overstatement of the NAV. The third determinant, based on disclosures of
173
The market
discount of
property
developers’
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