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Certified Public Accountants & Consultants
Celebrating 40 Years of Serving You

1st QUARTER
REAL ESTATE ROUNDTABLE
Real Estate Fair Value
Accounting
Jeff Olson, CPA
Babush, Neiman, Kornman & Johnson, LLP
www.bnkj.com
Real Estate Fair Value
Accounting
“Historic cost numbers are
reliable and relevant only on the
day they are recorded”
Rebecca McEnally, VP Advocacy AMR
Fair Value Accounting
Why Fair Value?

It is GAAP for tax-exempt
(pension/benefit plan) investors (FAS
35)

Useful supplemental reporting to
GAAP historical cost
It’s allowed
 Likely more relevant than historical cost

Fair Value Accounting
Other GAAP & international
accounting standards indicate
movement to FV

See article “Question of Value”
CFO Magazine, February 2003

As Bob Dylan said, “The times they
are a changin”
GAAP FV Accounting
GAAP FV Based Pronouncements

Loan impairment (FAS 114)
 Impairment of long-lived assets (FAS 121/144)
 Marketable securities (FAS 115)
 Stock based compensation (FAS 123)
 Hedging derivatives (FAS 133)
 Business combinations (FAS 141)
 Purchased intangibles (FAS 142)
 Guarantee liabilities (FAS FIN 45)
International Accounting
International Accounting Standard
40 (“IAS 40”) January 2001

FV for investment property
Use as accounting basis
 If retaining historical cost, must
disclose FV in notes


Should we be concerned with IAS
Standards?
International Accounting
Standards
Who cares, not U.S.
 10/29/02 FASB & IAS announce project to
begin “convergence” of global standards
12/15/03 FASB issues initial exposure drafts
under convergence project

FASB chairman Herz is former IAS member
& originally from UK not America

May Full FV Be Better?

GAAP patch work


Some measurements at HC, others at FV
Some changes in measurements go to P&L,
others go through “OCI” which is often
presented in the equity statement

Greater earnings volatility

Only FV’s assets and liabilities; does
not


Value “going concern” business, ability to
capitalize on future opportunities
Establish share prices of public companies
U.S. RE FV Accounting
Currently driven by pension
professionals - Real Estate
Information Standards (REIS)

National Council of Real Estate
Investment Fiduciaries (NCREIF)

National Association of Real Estate
Investment Managers ( NAREIM)
Pension Real Estate Association
(PREA)

REIS

Updated annually and covers
 Valuation
 Accounting
& related disclosures
 Investment performance measurement &
reporting

Draws from
 AICPA
 FASB
 AIMR
 Appraisal
Standards Board
REIS
Adds established “industry practice”
to increase comparability/reliability


Includes investments in
 Wholly owned real estate

JV real estate
 Debt investments in real estate
REIS Continued

Addresses issues unique to
investment real estate not covered by
AICPA Investment Company Guide

REIS Appendix 1- NCREIF Market Value
Accounting Policy Manual

Available at ncreif.org
REIS, including MV manual
 NCREIF Debt Accounting Workbook

FV Accounting

FV minus cost = unrealized gain or
loss at a point in time

Balance sheet is fair value at a
point in time
FV Accounting

Change in unrealized gain loss (or
differences in net changes in FV and
cost) over a period of time runs
through the P&L

Realized g/l is factored out of the
gross change in unrealized
FV Accounting Basic Model
Cost
Balance Sheet
FV
Unreal. G/L
Balance 1/1/xx
10,000
15,500
5,500
Plus additions
3,000
3,000
0
(4,000)
(4,700)
Less disposals (at last FV)
Change in FV, assets held during the period
Balance 12/31/xx
(700)
0
4,000
4,000
9,000
17,800
8,800
Realized G/L
700
700
FV Accounting Cost Concepts

No depreciation or amortization
 No rent normalization (stepped or free
rent receivable)
 No impairment adjustments
 Certain deferred costs that have no
value are expensed, formerly
organizational cost
 Capital additions
Those
that increase value
Those that do not
FV Accounting -FV Concepts
Real Estate is most often valued using
a discounted cash flow method (DCF)
particularly if an income producing
property
 Projected rent and expenses

Projected capital expenditures
 Projected disposition proceeds and
expenses
FV Accounting -FV Concepts
Debt adjustments depend on

Likelihood of entity-level interests
trading
 If interests likely to trade, then debt
valued at PV of expected future CF’s
If interests not likely to trade, valued at
current settlement value excluding
transaction costs

FV Accounting -FV Concepts
Debt adjustments depend on

If debt is transferable/assumable
Even if interests not likely to trade value
at PV of future CF’s

 Fixed rate or variable rate
Variable rate usually has no FV
adjustment for I-rate

FV Accounting - FV Concepts
NCRIEF Debt Accounting Workbook- Examples
A-J with DCF calculations
 Each has trading and non-trading of equity interests
value
 Transferable & non-transferable debt
 Favorable & unfavorable interest rates
 Debt to be prepaid & pending foreclosure
 Interest buy-down
 Financing costs, predetermined prepayment & yield
maintenance
FV Accounting - FV Concepts
Non real estate assets/liabilities
 Short term held at un-discounted
values

Long term must be valued at time
value discount not to exceed value in a
current transaction

Changes go through P&L like real
estate
FV Accounting - FV Concepts
Real estate JV investments

If subject to consolidation, treat as
wholly owned real estate with
minority interests

Otherwise
Use equity method of historical
accounting (cost method would
seldom be used)
 Value JV assets/liabilities
 Apply hypothetical liquidation

FV Accounting -FV Concepts
Real estate debt investments

Nonparticipating loans
 At
market value, considering future CF’s,
risks, collateral value, guarantees

Participating loans
 If
considered ADC arrangements, value
as a JV interest
 Non-ADC, value as a nonparticipating
loan
FV Accounting
Examples
REIS
has illustrated statements &
disclosures example
Fannie Mae 10-K financials
FV balance sheet in supplemental
note
 PWC addresses FV disclosure in
audit opinion
 FMNA Website “Answers from the
CEO”
 NYT article on FV balance sheet &
reporting “core earnings” vs. GAAP
net income
FNMA Reporting
Pick a Measure - in millions
GAAP net income
Purchased options adjustment:
Add back FAS 133 FV adjustment
Deduct S/L amortization
Income tax effect
Net adjustment
"Core Earnings"
4,619
4,545
(1,814)
(956)
1,775
FV equity 12/31/01
FV equity 12/31/02
Net decrease in FV
22,675
22,130
(545)
Add back:
Dividends-common
Dividends-preferred
Repurchase common
Net treasury and preferred issued/redeemed
1,409
99
1,167
(854)
Change in FV, excluding capital transactions
1,276
6,394
FAS FIN No. 46 Update
FASB Staff Positions & Revised
FIN No. 46 , December 2003
Babush, Neiman, Kornman & Johnson, LLP
www.bnkj.com
FAS FIN No. 46
Consolidation of variable
interest entities (VIEs) originally
issued January 2003

Who has majority risks and
rewards?
 Equity owner (s) - expected losses
& residual returns
 Contractual parties
Primary
beneficiary - must
consolidate
 May be a non equity owner &
voting control is no longer the
consolidation basis
FIN 46 - FASB Staff Positions
FSP FIN 46-1 to 46-8

See hand out summary & copies
of each
 No’s 3, 4, 6 & 7 were also
incorporated in newly issued
revision to FIN 46 or “FIN 46 (R)”
FIN 46 - FASB Proposed Staff
Positions
FSP FIN 46-a to 46-f

See hand out summary & copies

All but “d” have either been issued or
were encompassed in FIN 46 (R)
FAS FIN No. 46 (R)
December 2003 revision

Available on fasb.org
Handout - 41 paragraph “redline”
version
 Full text FIN 46 (R) w/appendices


Effective dates & transition
covered in 15 paragraphs (para. 2741)
Disclosure only by 12-31-03
 Full application is staggered by type
entity

FAS FIN No. 46 (R)
Effective dates & transition for
public companies
 “Large” public Co’s - generally,
3/15/04
“Small business issuer” - generally,
12/15/04


Exceptions to each
“Special purpose entities” by 12/15/03
Continue to apply to entities to which
“original” FIN 46 was previously applied


FAS FIN No. 46 (R)
Effective dates & transition for
private companies

New entities formed after 12/31/03 immediately

All others - by 12/15/04
FAS FIN No. 46 (R)
Investment company effective dates

Registered investment companies
specifically excluded para 4(e)

Non registered investment companies
following AICPA Audit Guide
Effective date deferred while AICPA
finalizes a proposed SOP on scope of the
guide to parent companies & other equity
investors in investment companies

FAS FIN No. 46 (R)
Disclosure requirements
Remember that enterprises with
“significant” interests in VIEs have
certain disclosure requirements even
if a non-consolidating Primary
Beneficiary