Chapter 21

Due Diligence Guidelines –

Inspection of Assets and Property Valuers’ Reports

2. Property Valuers’ Reports

2.1 Standards

2.1.1 At the time of issue of a listing document, a sponsor as a non-expert, after performing the due diligence set out in Paragraph 17.7 of the Code of Conduct, should have no reasonable grounds to believe and should not believe that the information in the expert reports is untrue, misleading or contains any material omissions. [Paragraph 17.5(c) of the Code of Conduct]

2.1.2 [For the purposes of Paragraph 17.5(c) of the Code of Conduct,] if an expert relies on information prepared by a third party, e.g., where a legal adviser is engaged to confirm the title of properties, the sponsor should follow the procedures set out in Paragraph 17.6(g) of the Code of Conduct. If an expert who relies on information prepared by a third party also follows standards which are at least equivalent to those required under Paragraph 17.6(g), the sponsor may rely on the work performed by the expert in that respect. [Note 2 to Paragraph 17.7(b) of the Code of Conduct]

2.2 Guidance

Generic standards and guidance

2.2.1 See Chapter 18 “Due Diligence Guidelines – Interaction with Third Parties including Expert Advisers” for the generic standards and guidance under Paragraph 17.6(g) of the Code of Conduct when seeking assistance from third parties.

2.2.2 See Chapter 18 “Due Diligence Guidelines – Interaction with Third Parties including Expert Advisers” for the generic standards and guidance under Paragraph 17.7 of the Code of Conduct for due diligence on expert reports, including property valuers’ reports.

2.2.3 See Chapter 19 “Due Diligence Guidelines – Foreign Lawyers” for the generic standards and guidance on foreign law and foreign legal opinions.

Valuation requirements

2.2.4 Basic principles: In the case of a listing applicant’s property interests, the listing applicant must include valuations of and information on property interests:7

(a) that form part of its property activities except for those with a carrying amount below 1% of its total assets. The total carrying amount of property interests not valued must not exceed 10% of its total assets.8 The listing document must include: (i) the full text of valuation reports of such property interests except where summary disclosure is allowed; and (ii) a summary disclosure9 if the market value of a property interest as determined by the valuer is less than 5% of its total property interests that are required to be valued; and

(b) that do not form part of its property activities if the carrying amount of a property interest is or is above 15% of its total assets. The listing document must include: (i) the full text of valuation reports of such property interests; and (ii) a statement that, except for the property interests in the valuation reports, as at the date of the listing document,10 no other single property interest that forms part of its non-property activities has a carrying amount of 15% or more of its total assets. Calculation of whether the 15% total assets threshold has been exceeded is on an individual property, and not on an aggregated, basis.

“Property activities” mean holding (directly or indirectly)11and/or development of properties for letting or as investments. It does not include holding of properties for own use.12 Retail outlets occupied by a listing applicant for its operations should be categorised into non-property activity.13

In the case of a Mineral Company listing applicant, the requirements of paragraphs 2.2.4(a) and (b) do not apply to property interests which are ancillary to the exploration for and/or extraction of Natural Resources if the listing document includes a valuation of all these ancillary property interests and Natural Resources conducted by a Competent Evaluator. The terms “Mineral Company”, “Natural Resources” and “Competent Evaluator” have the meanings given in Chapter 18 of the Listing Rules.

Even if a valuation is not required in accordance with paragraphs 2.2.4(a) and (b), the sponsor must still consider whether valuation information is needed to satisfy the general requirement for the listing document to contain sufficient particulars and information necessary for an investor to make an informed investment decision.14

2.2.5 Valuation standards: All valuation reports must contain all material details of the basis of valuation which must follow The Hong Kong Institute of Surveyors Valuation Standards on Properties or the International Valuation Standards published by the International Valuation Standards Council.15

2.2.6 Specific contents’ requirements: Furthermore, there are prescribed, specific contents’ requirements for valuation reports. All valuation reports should normally contain, among other things, details of title and ownership of each property.16

2.2.7 Effective date: The effective date as at which the property was valued must not be more than three months before the date on which the listing document is issued, and if such effective date is not the same as the end of the last period reported on by the reporting accountants, it will be necessary for the listing document to include a statement reconciling the valuation figure with the figure included in the balance sheet as at the end of that period.17

2.2.8 Other valuation reports:

(a) If the listing applicant has obtained more than one valuation report regarding any of its properties referred to in the listing document within three months before the issue of the listing document, then all such other reports must also be included in the listing document.18

(b) For a listing applicant whose accounts at the last balance sheet date disclose that either a value exceeding 10% of the value of its assets or a value of not less than HK$3,000,000 is placed on its interests in land or buildings, if it has obtained more than one valuation report regarding any of its interests in land or buildings within six months before the issue of the listing document, then all such other reports shall also be included.19

Qualitative disclosure requirements

2.2.9 A listing applicant also has to disclose in the listing document:

(a) an overview of property interests not covered by a valuation report, including their number and approximate size range, uses, how they are held and the general description of the area where they are located. The overview may include property interests voluntarily valued and disclosed separately in the listing document;20 and

(b) certain descriptive information on its material properties, such as details of charges, liens against the property, title defects, etc. Such information is required to be disclosed irrespective of whether a valuation report is required to be included in the listing document.21

2.2.10 In respect of properties with defective titles in Hong Kong and the PRC, the listing applicant has to disclose in the listing document the following information:

(a) the reason(s) for the properties with defective titles, the usage of the defective properties, and the amount of maximum potential liabilities to the listing applicant (in monetary terms);

(b) the view from the listing applicant’s directors, with basis for such view, on whether the properties with defective titles are individually or collectively crucial to the listing applicant’s operation;

(c) the safety conditions of buildings which have not obtained building ownership certificates or undertaken the completion inspection of construction work as required under relevant local rules and regulations;

(d) a lawyer’s opinion, with basis for such opinion, on whether the existence of title defects will prevent the property from being bought, sold or being accepted by banks as security for mortgages;

(e) the difference in land cost/rental the listing applicant would have to pay if the properties did not have defective titles (or an appropriate negative statement);

(f) the remedial actions taken or to be taken by the listing applicant (or reasons for not taking any remedial actions), whether there are any legal impediments to obtaining the outstanding certificates/permits and when the applicant expects to obtain them; and

(g) the estimated time and cost for relocation and/or demolishment and loss of revenue and other related loss (if any), with basis for such estimate, and how the possible relocation and/or demolishment would affect the listing applicant’s business and financial position.22

2.2.11 For a listing applicant which has included a valuation report and a property market report in its listing document, the Stock Exchange has issued guidance to require sufficient disclosure on the bases and justifications of assumptions underlying both reports. According to the guidance, the listing applicant should benchmark the assumptions adopted with historical data for a prolonged period to enable investors to assess the reasonableness of those assumptions and explain their material fluctuations. The Stock Exchange may also require a sensitivity analysis on the valuation of the properties where possible.23

PRC properties

2.2.12 Where the property is situated in a developing property market (including the PRC), the valuation report must state whether the relevant party has vested legal title to the relevant property. The listing document should also contain a statement of such fact and any material conditions affecting title. The statement should summarise the material information regarding title and other relevant matters contained in any legal opinion (in the case of properties in the PRC, an opinion should be obtained in accordance with the Listing Rules).24 The Listing Rules also set out specific contents’ requirements for a valuation report of such properties.25 In addition, the Stock Exchange has issued guidance on the disclosure in listing documents of properties with defective titles, idle land, civil defence projects and land resettlement operations in the PRC.26

2.2.13 The Stock Exchange generally requires listing applicants which are infrastructure project companies and property companies to obtain land use right certificates and/or building ownership certificates (“Title Certificates”) for all properties situated in the PRC. The Stock Exchange does not require Title Certificates for PRC properties for other applicants – instead, they are expected to disclose the risks to their operations of not having Title Certificates in their listing documents.27

Specific standards

2.2.14 See Chapter 23 “Due Diligence Guidelines – Mineral Companies”.

2.3 Recommended Steps

Valuation report

2.3.1 The sponsor should determine (with the assistance of the auditors) whether the listing applicant is engaged in any “property activities”28 and the carrying amount of the property interests29 involved in any property activities or non-property activities, so as to determine if a valuation is required for any of the listing applicant’s property interests, in accordance with paragraphs 2.2.4(a) and (b).

2.3.2 The valuer will prepare a valuation report on those property interests required to be valued in accordance with applicable laws and rules and the relevant professional standards applicable to valuers and surveyors. The sponsor may rely on the expertise of the valuer (see paragraph 2.2.2) and is not required or expected to check/confirm that the valuer’s work and the valuation report comply with those laws and rules and professional standards, which remains the primary responsibility of the valuer.

Title opinion / tenancy report / rent roll / title searches

2.3.3 Lawyers in the relevant jurisdiction in which the relevant property is located should be engaged to:

(a) issue a legal opinion to confirm the title (and other issues, as required under applicable laws and rules) of the material property interests owned by the Group, and all other property interests owned or leased (as a tenant) by the Group which are valued and located in a developing market (see also paragraph 2.2.12 above);

(b) issue a tenancy report to confirm the key tenancy provisions of:

(i) the property interests owned and leased (as a landlord) by the Group; and

(ii) the property interests leased (as a tenant) by the Group,

which are, in each case, material to the business of the Group – or an appropriate sample size of such interests.

Where the tenancy constitutes a continuing connected transaction under the Listing Rules, the listing applicant will apply to the Stock Exchange for a waiver from the announcement, circular and shareholders’ approval requirements. The sponsor is required to state in the listing document whether the tenancy is in the ordinary and usual course of business of the listing applicant, on normal commercial terms, is fair and reasonable and in the interests of the shareholders as a whole.30 For this purpose, the sponsor will need the valuer to confirm, e.g., that the terms and conditions of the tenancy agreement are on normal commercial terms and conditions and/or that the rental received or paid, as the case may be, by the listing applicant under the tenancy is no less favourable than that offered by an independent third party; and/or

(c) where reliance is being placed by the sponsor for its due diligence exercise, or a valuer for its valuation, on a rent roll prepared by the listing applicant setting out the particulars of the tenancies of the property interests owned and leased (as a landlord) by the Group – review such rent roll or an appropriate sample size of such interests; and check and confirm the accuracy and correctness of the disclosed data and information.

The considerations for determining materiality and sample size are similar to those for site visits – see paragraphs 1.2.2 and 1.2.5. For property interests owned by the Group where no title opinion is obtained, consideration may also be given to engage lawyers to carry out property title searches, where this facility is available, to verify ownership although the cost involved must be carefully balanced against the utility of doing so.

2.3.4 Both the title opinion and the tenancy report should be addressed to the sponsor. Typically, the lawyers would, based on a list of bases and assumptions and subject to a list of conditions and exceptions, essentially confirm/certify, among other things:

(a) in the case of the title opinion: (i) that the relevant member of the Group is the legal and beneficial owner of the relevant property; (ii) that the relevant documents checked do not reveal encumbrances and third party rights; and (iii) the permitted use of the property and whether any illegal/unauthorised structures (e.g., outstanding building orders) are revealed and apparent from the relevant documents checked; and

(b) in the case of the tenancy report: (i) information such as usage, lease term, rental and rent review/revision provisions about the tenancy; (ii) that the tenancy has been duly stamped and registered; (iii) whether there is a break clause by the landlord/tenant, option to renew by the tenant, restriction against assignment or subletting by or change in control of the tenant; (iv) whether there are any unusual or onerous obligations on the tenant; (v) that no mortgagee’s consent is required/outstanding and the landlord has the right to lease out the property to the tenant; and (vi) that the directors of the listing applicant have confirmed that the tenancy is in full force and effect and all relevant consents and approvals have been obtained.

The above confirmations/certifications are examples only. The scope of the title opinion and tenancy report should be adjusted according to the circumstances of each case and agreed between the working parties at an early stage of the preparation for the listing application.

Expert / non-expert third party

2.3.5 A valuation report, and any other part of a listing document which is an extract from a property valuer’s report, opinion, statement or valuation, where the valuer has consented to the inclusion of such report or extract in the listing document (“Extracted Information”),31 will be an expert report for the purposes of Paragraph 17 of the Code of Conduct. The sponsor should therefore perform the procedures set out in Paragraph 17.7 of the Code of Conduct with respect to the property valuer, the valuation report and any Extracted Information (including being satisfied with the valuer’s competence, qualification, experience and independence,32 its scope of work and the methodology used). After performing those procedures to the standard of a sponsor which is not itself an expert in property valuation matters, the sponsor should have no reasonable grounds to believe, and should not believe, that the information in the valuation report or any Extracted Information is untrue, misleading or contains any material omissions. See the guidance on the due diligence the sponsor should conduct in respect of experts and expert reports in Chapter 18 “Due Diligence Guidelines – Interaction with Third Parties including Expert Advisers”.

2.3.6 A legal opinion which is included in a listing document, and any other part of a listing document which is an extract from a law firm’s opinion, statement or report, which has been included in the listing document with the lawyers’ consent, will be an expert report for the purposes of Paragraph 17 of the Code of Conduct and the sponsor should perform the procedures set out in Paragraph 17.7 of the Code of Conduct with respect to the lawyers, and their legal opinion and any such extract included in the listing document with their consent. Where the non-expert sections of the listing document include information derived from advice or statements made by lawyers which is within their general competence as lawyers (e.g., where the sponsor engages lawyers to undertake verification of title to properties), the sponsor should treat the lawyers as non-expert third parties for the purposes of Paragraph 17 of the Code of Conduct and should perform the procedures set out in Paragraph 17.6(g) of the Code of Conduct in relation to the lawyers and their work. See the guidance on the due diligence the sponsor should conduct in respect of non-expert third parties and their work in Chapter 18 “Due Diligence Guidelines – Interaction with Third Parties including Expert Advisers”.

Review

2.3.7 The sponsor should review the valuer’s valuation report, the lawyers’ legal opinion, tenancy report and/or property title searches and the listing applicant’s rent roll and check for consistency between them and for consistency with the sponsor’s knowledge and understanding of the listing applicant, its business and its business plans (including information from the sponsor’s site visits and from the auditors’ report) and its industry sector and comparable companies.

2.3.8 The sponsor should also assess the material bases and assumptions underlying the reports and opinions, consistent with the generic standards referred to in paragraphs 2.2.1 to 2.2.3.

2.3.9 The sponsor should critically review the valuation methodology used (and its key bases and assumptions) against all the information known to the sponsor about the listing applicant through due diligence and the sponsor’s knowledge and experience of the listing applicant, the market in which the listing applicant operates and of comparable companies. See also paragraph 2.2.11.

2.3.10 The sponsor should check if, historically, other valuation reports have been obtained for the same property. Those obtained within the last six months may be required to be included in the listing document (see paragraph 2.2.8). In any case, the sponsor should conduct a sanity check against the historical reports for any material discrepancies (and consider any possible justifications for the discrepancies with the listing applicant and the valuer), especially where the report is a recent one that is required to be included in the listing document.

2.3.11 Where a profit forecast is included in the listing document, there have been cases where the Stock Exchange has required that specific assumptions in respect of investment property valuations be included in the profit forecast. Such assumptions may include the following (where relevant): (a) the relevant governments will not introduce material changes or impose additional austerity measures to dampen the sales and prices of the real estate markets; (b) the conditions under which the investment properties are being operated and which are material to the revenue and costs of the properties remain unchanged; (c) property-specific factors such as the building facilities and building specifications remain unchanged; and (d) the leases of all units of the relevant properties will be renewed upon expiry on normal commercial terms. As such, the sponsor should obtain appropriate comfort from the valuer on the bases of those assumptions. See section 14.7 of Chapter 12 “Due Diligence Guidelines – Financial” which specifically discusses the impact of, among others, investment property gains/losses on a profit forecast.

2.3.12 The sponsor should follow up on any issues with the valuer, lawyers, representatives from the listing applicant and with other working parties, as appropriate, and determine the appropriate action to be taken.

2.4 Miscellaneous

References in this chapter to legal opinions on title also include certificates of title, being a form of confirmation commonly used for title to real property.

Endnotes

7. Chapter 5 of the Listing Rules, in particular, Listing Rules 5.01A and 5.01B(1) and (2).

Paragraph 34(2) of the Third Schedule to the Companies (Winding Up and Miscellaneous Provisions) Ordinance also requires a valuation report with respect to all the listing applicant’s interests in land and buildings, for every listing applicant whose accounts at the last balance sheet date disclose that either a value exceeding 10% of the value of its assets or a value of not less than HK$3,000,000 is placed on its interests in land or buildings. Under section 6 of the Companies (Exemption of Companies and Prospectuses from Compliance with Provisions) Notice (Chapter 32L of the Laws of Hong Kong) (“Companies Ordinance Exemption Notice”), if it is proposed to offer any shares in or debentures of a company by a prospectus issued generally, then, subject to conditions which are essentially the same as the Listing Rules’ requirements for valuation reports plus a condition relating to the paid up capital and net asset value of the valuer, the prospectus is exempted from compliance with the relevant requirements of the Companies (Winding Up and Miscellaneous Provisions) Ordinance in relation to paragraph 34(2) of the Third Schedule to the Companies (Winding Up and Miscellaneous Provisions) Ordinance.

8. FAQ No. 7 of FAQ Series 15 provides guidance as to how a listing applicant should identify properties up to the 10% limit. According to that FAQ, generally, a listing applicant should identify the carrying amount of each property interest and add up from the lowest values until the 10% limit is reached. Property valuations will not be required for property interests comprising the lowest 10%. Property valuations will be required for the remaining property interests.

Where two properties have similar carrying amounts that would cross the 10% limit, the Stock Exchange would leave it to the listing applicant and its advisers to determine which property should be valued taking into account the general disclosure obligation.

9. Appendix 26 to the Listing Rules provides a summary form of disclosure. The Stock Exchange may accept variation of the summary form based on each listing applicant’s circumstances, and the applicant must include additional information necessary for investors to make an informed decision. The valuation report setting out the information must be available for public inspection. See also sections 6(3)(d) and 6(6) of the Companies Ordinance Exemption Notice.

10. FAQ No. 8 of FAQ Series 15.

11. According to FAQ No. 5 of FAQ Series 15, “holding (directly or indirectly)” includes property interests that are recognised in the consolidated balance sheet of the listing applicant. Whether a property interest held by a jointly controlled entity is recognised in the consolidated balance sheet of the listing applicant depends on the accounting treatment adopted by that applicant.

12. Listing Rule 5.01(2).

13. FAQ No. 6 of FAQ Series 15.

14. FAQ No. 1 of FAQ Series 15, paragraph 3 of the Third Schedule to the Companies (Winding Up and Miscellaneous Provisions) Ordinance and Listing Rule 11.07.

15. Listing Rule 5.05.

16. Listing Rule 5.06. Listing Rule 5.06(9) provides that valuation reports shall contain such other information as the Stock Exchange may require. Practice Note 12 of the Listing Rules sets out the information to be included in a valuation report under Listing Rule 5.06(9) for properties situated in a developing property market. See also sections 6(3)(b) and 6(4) of the Companies Ordinance Exemption Notice.

17. Listing Rule 5.07. See also section 6(3)(a) of the Companies Ordinance Exemption Notice.

18. Listing Rule 5.09.

19. Paragraph 34(4) of the Third Schedule to the Companies (Winding Up and Miscellaneous Provisions) Ordinance.

20. Listing Rule 5.01B(3). See also section 6(5) of the Companies Ordinance Exemption Notice.

21. Listing Rules 5.01B(4) and 5.10, FAQ No. 10 of FAQ Series 15 and Exchange Guidance Letter GL19-10. This Guidance Letter also applies to defective titles in Hong Kong.

In Exchange Listing Decision LD48-2013, the Stock Exchange provides guidance on why certain listing applications were returned. In one of the cases studied which involves a GEM listing applicant, there were several deficiencies in disclosure. Among such deficiencies, there was no disclosure on the reason for the absence of title certificates for that listing applicant’s production facilities, the estimated impact on it in case of forced eviction, the legality of the lease agreement in respect of collectively-owned land, and analysis on the adequacy and sufficiency of contingency measures.

22. Exchange Guidance Letter GL19-10.

23. Exchange Guidance Letter GL19-10.

24. Paragraph 5.1 of Practice Note 12 of the Listing Rules. Paragraphs 5, 6 and 7 of Practice Note 12 also describe requirements for legal opinions and related matters.

25. Paragraphs 8 and 9 of Practice Note 12 of the Listing Rules. According to paragraphs 13 and 17 of Practice Note 12, where the residual method is used in the valuation, the valuation report should include a general warning statement in the form attached to Practice Note 12, and where the relevant property assets represent substantially the whole or a majority of the assets of the listing applicant, the warning statement should, if applicable, also appear in the “Risk Factors” section of the listing document.

26. Exchange Guidance Letter GL19-10.

27. Ibid.

28. According to FAQ No. 4 of FAQ Series 15, a listing applicant can engage in both property activities and non-property activities, and should consider each property’s use. If a property is for letting or sale, then it would be categorised into property activity. So even where a listing applicant’s core business is not property development or investment, its property interest may still be categorised into property activity.

29. According to FAQ No. 3 of FAQ Series 15, the carrying amount of a property interest must be ascertainable from the books and records of the listing applicant and consolidated into its balance sheet. Disclosure of a breakdown of property interests in the listing document is not required.

The carrying amount of a property interest used to calculate the percentages under which a property valuation is not required should be the amount reported in the consolidated balance sheet of the listing applicant. It should not be the effective value based on the listing applicant’s percentage holding in the subsidiary (or the entity that is consolidated into the balance sheet). For example, an 80%-owned subsidiary of a listing applicant holds a property interest with a carrying amount of $200 million. The carrying amount of $200 million should be used instead of $160 million.

30. Listing Rule 14A.105.

31. See definition of “expert report” in Paragraph 17.15 of the Code of Conduct.

32. According to Listing Rule 5.08, unless dispensation is obtained from the Stock Exchange, all valuations of properties must be prepared by an independent qualified valuer, and for this purpose:

(a) a valuer is not independent if:

(i) he is an officer or servant or proposed director of the listing applicant or the listing applicant’s subsidiary or holding company or of a subsidiary of the listing applicant’s holding company or any associated company; or

(ii) in the case of a firm or company of valuers, it is the listing applicant’s subsidiary or holding company or a subsidiary of the listing applicant’s holding company or any of its partners, directors or officers is an officer or servant or proposed director of the listing applicant or the listing applicant’s subsidiary or holding company or of a subsidiary of the listing applicant’s holding company or any associated company; and

(b) a valuer is a qualified valuer only if:

(i) for the purposes of valuation of properties situated in Hong Kong, the valuer is a fellow or associate member of The Royal Institution of Chartered Surveyors (Hong Kong Branch) or The Hong Kong Institute of Surveyors (“HKIS”) and carries on the business in Hong Kong of valuing properties and is authorised to do so by the rules of the relevant professional institution of which he is a member; or

(ii) for the purposes of valuation of properties situated outside Hong Kong, the valuer has the appropriate professional qualifications and experience of valuing properties in the same location and category to carry out the valuation.

Under paragraph 4 of Practice Note 12 of the Listing Rules which regulates valuations of properties situated in developing property markets, for the purpose of valuing such properties, a valuer would normally be regarded as having the appropriate professional qualifications and experience if he is subject to the discipline of The Royal Institution of Chartered Surveyors (“RICS”) or the HKIS or professional body of similar standing to the RICS or HKIS and has a minimum of two years experience in valuing properties in the relevant location or has relevant experience to the satisfaction of the Stock Exchange. The professional qualifications of the valuer and his experience in valuing properties within the relevant location (and, where the valuation is made on behalf of a valuation company, his experience with the company) should be disclosed in the valuation report.

Under paragraph 46(c)(ii) of the Third Schedule to the Companies (Winding Up and Miscellaneous Provisions) Ordinance, the valuer must have a paid up capital of at least HK$1,000,000 and its assets must exceed its liabilities by at least HK$1,000,000 as shown in its last balance sheet.