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Babush, Neiman, Kornman & Johnson, LLP

Certified Public Accountants & Consultants

Real Estate Fair Value Accounting

Jeff Olson, CPA

Babush, Neiman, Kornman & Johnson, LLPwww.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 & internationalaccounting standards indicatemovement 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 Standard40 (“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 AccountingStandards

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 coversValuationAccounting & related disclosures Investment performance measurement & reporting

Draws fromAICPAFASBAIMRAppraisal 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

Balance SheetCost FV Unreal. G/L Realized G/L

Balance 1/1/xx 10,000 15,500 5,500

Plus additions 3,000 3,000 0

Less disposals (at last FV) (4,000) (4,700) (700) 700

Change in FV, assets held during the period 0 4,000 4,000

Balance 12/31/xx 9,000 17,800 8,800 700

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 valueThose 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/liabilitiesApply hypothetical liquidation

FV Accounting -FV ConceptsReal estate debt investments

Nonparticipating loansAt market value, considering future CF’s,

risks, collateral value, guarantees

Participating loans If considered ADC arrangements, value

as a JV interestNon-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 ReportingPick a Measure - in millions

GAAP net income 4,619Purchased options adjustment:

Add back FAS 133 FV adjustment 4,545Deduct S/L amortization (1,814)Income tax effect (956)

Net adjustment 1,775

"Core Earnings" 6,394

FV equity 12/31/01 22,675FV equity 12/31/02 22,130

Net decrease in FV (545)

Add back:Dividends-common 1,409Dividends-preferred 99Repurchase common 1,167Net treasury and preferred issued/redeemed (854)

Change in FV, excluding capital transactions 1,276

FAS FIN No. 46 Update

FASB Staff Positions & Revised FIN No. 46 , December 2003

Babush, Neiman, Kornman & Johnson, LLPwww.bnkj.com

FAS FIN No. 46Consolidation 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. 27-41)

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