The National Association of Real Estate Investment Trusts (NAREIT) held their annual REITWise conference in Phoenix, Ariz. The latest law, accounting, tax, and economic issues impacting Real Estate Investment Trusts (REITs) were addressed over the course of the conference. Highlights from some of the committee meetings and sessions are summarized below.
Accounting Committee meeting
The conference began with various committee meetings, including the Accounting Committee. Panelists discussed major accounting topics impacting the industry. The Financial Accounting Standards Board (FASB) issue an exposure draft on lease accounting almost two years ago and the panelists noted that the real estate industry is anxiously awaiting final guidance. The panelists discussed how the lease standard interacts with the recently issued guidance on revenue recognition. A panelist remarked that the final lease standard will likely not be effective until 2019 and, in order to allow for a smoother transition, the standard setters will likely push off the effective date for the revenue recognition standard to 2019 as well.
Discussion turned to the issuance of the consolidation standard in February. The purpose of the standard was to modify the analysis that an entity must perform in determining whether it should consolidate certain types of entities. Panelists covered the key aspects of the guidance, including:
- The evaluation of whether certain entities are variable interest entities (VIEs) or voting interest entities
- Considering substantive kick-out rights or participating rights when determining whether a limited partnership is a VIE
- Eliminating the presumption that a general partner should consolidate a limited partnership
The Accounting Committee meeting concluded with a discussion about NAREIT’s analysis of the use of funds from operations (FFO), a widely used key performance indicator for REITs. More than 95 percent of equity REITs report FFO in SEC filings according to NAREIT’s definition. Approximately half of REITs use a modified version of FFO. In September 2014, NAREIT sent a letter to many REIT executives requesting that REITs take a step forward and provide earnings guidance on NAREIT-defined FFO, in addition to the earnings guidance they are currently providing for company-defined FFO. NAREIT is concerned about the use of varying definitions of FFO by the industry, resulting in uncertainty around analysts’ published estimates. NAREIT is exploring this topic further and they have engaged the FASB on financial reporting performance.
State of the capital markets
A general session addressing the state of the capital markets kicked off the second day of event. Representatives from Evercore ISI, KeyBank, Forward Management, STORE Capital, and Lodging & Leisure Group comprised a diverse panel to discuss the various lending markets, equity markets and M&A activity.
The panelists began with a discussion of what they look for in a REIT’s management team before making a decision to invest. Investors place emphasis on whether a management team can generate cash flow in order to command a premium multiple on the valuation of the REIT. A panelist commented that companies should disclose their tenant lease terms and if those terms are relatively long, the management team must make a convincing argument that they have a strong operating platform.
On the topic of low interest rates around the world, the panel commented that analysts are closely following trends looking for signs of central bank actions or changes in employment data which may result in rising rates. One panelist noted that 11 years ago there was a surprise jobs report that was so strong it caused a 5 to 10 percent drop in REIT stock values. The panelist’s view was that while 2015 should be a positive year for REITs, as interest rates eventually rise, lower valuations are expected. The returns generated by REITs compared to other markets have proven that investment in the industry should generally be over the long-term.
Moving on to the topic of leverage and capital levels, several panelists agreed REITs should maintain low leverage and should consider buying back their stock if assets and stock prices are valued the same. REITs continue to raise equity to fund acquisition opportunities. 2013 was a record year for equity issuances and while 2014 saw fewer deals, overall volume is still relatively high.
REIT tax issues and SEC activity
Conference breakout sessions included a panel discussion of tax issues, a panel discussion of SEC actions, and the Public Company Accounting Oversight Board’s (PCAOB) impact on publicly traded REITs. The SEC panel discussed an SEC report card of 2014 REIT reporting and review of 10-K filings. The panelists agreed that PCAOB pressure on accounting firms has resulted in improved accounting by public filers. Public accounting firms are requesting better audit evidence from their clients due to demands being made on them from PCAOB inspections. A panelist remarked that this effort has been the most effective way for the regulators to affect change in the level of accounting sophistication for public REITs and other publicly traded companies. Another panelist echoed these observations and noted that REIT accounting and finance departments must make an effort to stay current on new accounting guidance and improve documentation. The SEC expects that most public REITs have already analyzed and implemented COSO 2013.
The SEC panel included an SEC official who discussed various issues a REIT should consider when acquiring a business, including whether there has been adequate disclosure about the potential acquisition and the existing leases the entity is taking on. The SEC asks the same questions they would ask when an entity creates a new lease. Companies should describe how they generate revenue, which are their significant tenants, and provide lease expiration schedules. It is also important to disclose key drivers of performance. Finally, if the SEC sees disclosures about REIT conversions and such disclosures do not include FFO in the filing, they will ask whether the REIT considers the measure to be a key performance indicator.
The tax panels discussed a number of topics including defining customary services, pitfalls of “baby REITs”, an update on transfer pricing, managing non-qualifying income from joint ventures, tax due diligence practices before acquisitions, managing built-in gains, and implementing internal controls in the tax function. During the discussion of transfer pricing, a panelist suggested an updated transfer pricing study every few years to support the REIT’s transfer pricing. Updating the study every five years will not be sufficient in the eyes of the IRS. The recommendation was to update the study, should something change so that the conclusions reached in the study do not go stale. For instance, intercompany loans need support for principal and interest rates used. REITs should document their methodology for shared services. The best practice is to have sufficient, robust documentation that is updated as facts change.
A tax panelist discussed internal control issues related to taxes. She noted many REITs may need to outsource some of the tax work to obtain adequate expertise. With a growth in M&A activity and more complex structures, REITs may need someone outside the existing accounting department to review the provisions. She emphasized that in-house tax staff must be sure the data they are obtaining from their accounting department is reliable and consider optimizing what they are doing by using technology.
REITWise 2015 provided attendees with an improving economic outlook for the real estate industry, with some caution as analysts closely monitor changes in interest rates and the impact of actions by central banks and regulators. Many important issues such as the issuance of a final lease accounting standard will impact REITs in the coming months.
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