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Authored by Brent Maier, Kevin Secrist, Nich Palkovic Baker Tilly’s third quarter 2020 report delves into the data and insight of the following specific sectors: multifamily housing, office, retail, industrial, senior housing and skilled nursing, and capital markets. Additionally, we include the results of a market survey regarding COVID-19 and its impact on commercial real estate. A second quarter that was defined by crisis and uncertainty gave way to a third quarter characterized by a disjointed recovery that had definite winners and losers. Economically, lower income workers and those in the hospitality industries and others directly impacted by COVID-19 continued to struggle, while technology companies saw their valuations soar given the role technology will play in everyday life and health delivery. Through a real estate lens, the industrial sector, which had been favored over the last five years, attracted even more attention and investment as large players such as Amazon push to expand their distribution and storage networks, while retail struggles were multiplied and accelerated. The office sector remains relatively stable for now. The reality is that the future of office is still uncertain. With subleasing activity increasing, coworking companies are breaking and terminating leases while many office employees are still working out of their homes, and the future of office is murky. The senior housing sector has been on the front line of COVID-19 and has seen its share of challenges – detailed further in the report.
Additional market reports
Commercial real estate market report: Q2 2020 For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.

A Q3 2020 commercial real estate market report for the multifamily housing, office, retail, industrial, senior housing and capital markets sectors.

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Retail

Senior Services

Structured Finance & Capital Markets

Commercial real estate market report: Q3 2020

Authored by Brent Maier and Kevin Secrist Baker Tilly’s real estate market report provides a recap of 2020’s second quarter, including market insight, data and analytics on the following sectors: multifamily housing, office, retail, industrial, hospitality and capital markets. Significant global and domestic issues have caused a halt to the commercial real estate market that was humming along in the first quarter of 2020. Real Capital Analytics reported that sales of commercial property sank again in May to their lowest levels since 2010, with no sector avoiding the decline. The industrial space experienced the smallest decline while retail and hospitality exhibited the most significant decline. Real Capital Analytics also notes that the number of deals in the United States falling out of contract is increasing, reaching 2.9% in May up from 2.1% in April and 0.7% in March. Market participants have reported deals falling apart due to an inability to close financing or buyers giving up earnest money (and in some cases entity policies) to avoid a transaction for which the fundamentals are no longer appealing. Notably, in April Blackstone Group exited a potential $405 million deal, giving up a $20 million deposit in doing so. The same week and in the same city, Kaiser Permanente canceled plans for a $900 million headquarters.
Additional market reports
Commercial real estate market report: Q3 2020 For more information on this topic, or to learn how Baker Tilly specialists can help,  contact our team.

A commercial real estate  market report for Q2 2020, providing analysis and trends in multifamily  housing, office, retail, industrial, hospitality and capital markets  sectors.

Commercial real estate market report: Q2 2020

Presented by
Mike Kamienski, Partner, CPA, Baker Tilly 
David Jamiolkowski, Partner, CPA, Baker Tilly 
Brent Maier, Managing Director, Baker Tilly 
Dennis Power, CFO, Opus Group 
John Thomas, CEO, Physicians Realty Trust The economic disruptions from COVID-19 has had significant impact on the credit quality of tenants, building occupancy and demand from buyers resulting in substantial uncertainty in the valuation of commercial real estate and complexity in the accounting for lease modifications. John Thomas, CEO of Physicians Realty Trust, and Dennis Power, CFO of the Opus Group, share their experiences with tenant collections, lease concessions, market demand and the resulting impacts on real estate valuation across their market niches. Brent Maier provides his view on the impacts he has seen in his role as the leader of Baker Tilly’s real estate transaction advisory services team while Mike Kamienski and David Jamiolkowski, also from Baker Tilly, share their view of how these issues will impact financial reporting from a real estate impairment and lease accounting perspective. Listen to this discussion of critical topics so you understand the valuation and leasing impacts from COVID-19. This webinar is open for anyone to view, please register to access the webinar.  

Leaders in the real estate industry discuss the impact of COVID-19 on valuation and leasing.

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Coronavirus Resource Center

The Impact of COVID-19 on real estate valuation and leasing

Authored by Brent Maier, David B. Jamiolkowski, Marsha Ackerman, Kevin Secrist, Nich Palkovic Due to business disruptions caused by COVID-19 and the impact on the global economy, the real estate industry expects to see a substantial amount of lease modifications for lessors and lessees. Rent collection levels are a leading indicator of the need for lease modifications, given their direct relationship to tenants’ abilities to meet their contractual rent obligations. The following data, published by the National Association of Real Estate Investment Trusts (NAREIT) on April 20, 2020 [1], summarizes April 2020 rent collections by property sector as a percentage of the expected or typical amount of rent collected prior to the onset of the COVID-19 pandemic. This data was based upon a survey of real estate investment trusts (REITs) and highlights how COVID-19 is affecting rent collections, particularly for those industries most impacted by shutdowns and social distancing.  As tenants face financial pressure, significant accounting implications will arise – specifically with leases. Some repercussions are: Tenant failure to pay rent Rent concessions Termination or amendment/extension of leases  Impairment of right-of-use assets (view our white paper: Long-lived real estate asset impairment: testing and fair value measurement in response to COVID-19) All of the above could lead to a need for lease accounting adjustments in connection with Accounting Standards Codification (ASC) Topic 842. Lease modifications In response to the current environment, the Financial Accounting Standards Board (FASB) issued a Q&A for Topic 842 and Topic 840: Accounting for Lease Concessions Related to the Effects of the COVID-19 Pandemic. Regardless of which FASB standard a company follows for lease accounting, the guidance related to accounting for lease concessions remains similar. Treating lease concessions The treatment of lease concessions is dependent upon whether contractual terms provide enforceable rights and obligations for concessions (e.g., force majeure, co-tenancy clause or default provision). If a contract provides these rights and obligations, then the concession is generally not considered a lease modification; if it does not, then the concession is likely a lease modification, which requires an evaluation of the lease classification for the lessor and lessee. In many cases, this represents a significant burden to evaluate each lease contract for these provisions and perform an evaluation of lease classification for each lease that does not have these provisions. In the Q&A, the FASB recognized the costs and complexities of accounting for lease modifications that arise due to stay-at-home orders and rent deferral requirements imposed by certain localities, including the challenge of addressing the sheer volume of anticipated lease concessions due to the COVID-19 pandemic.  As a result, the FASB determined it would be acceptable for an entity to make an election to account for lease concessions resulting from the effects of the COVID-19 pandemic under Topic 840 or 842 as though enforceable rights and obligations for such concessions existed in the original lease contract, as long as the concessions do not result in a substantial increase in the rights of the lessor or obligations of the lessee. If the election is made and the “substantial increase” criteria has not been met, an entity will not need to evaluate each lease contract for such clauses, and can avoid lease modification guidance that would require an evaluation of the lease classification for each lease. Lease concessions in use So what might this look like in practice? Let’s assume a lease concession provides for the deferral of payments, but there is no substantial increase to the overall consideration in the original lease contract. One option provided by the FASB would be to account for the lease concession as if no changes were made to the lease contract. The lessor would continue to recognize income and a lessee would continue to recognize expense during the deferral period as though the lease were unchanged. The lessor’s balance sheet would reflect an increase in the lease receivable and the lessee’s balance sheet would reflect an increase in the lease payable.  Another option provided by the FASB would be to account for the deferred payments as variable lease payments, in which case the lessor would recognize revenue and the lessee would recognize expense in the period in which such payments actually occur. In practice, the lessor would continue to recognize income and a lessee would continue to recognize expense during the deferral period as though the lease were unchanged. However, the lessor would also recognize the concession as negative variable rent in the period the concession relates, reducing income by the rent concession for the month. The lessee would recognize the concession as a reduction of recognized expense. Where fixed rent increases over the original lease term, there could be a difference between the straight-line rent recognized under the original lease agreement and the rent concession recognized as a negative variable lease payment. More complex questions arise when a lessor agrees to grant current rent concessions by increasing lease payments later in the term, or create a deferent rent obligation (i.e., a balloon payment due at the end of the lease term). The critical question is whether these changes resulted in a “substantial increase” in the rights of the lessor or obligations of the lessee. Although the FASB did not give any bright-line tests to evaluate what is considered substantial, the use of substantial, as opposed to the “material in the context of the contract” language of ASC 606, Revenue from Contracts with Customers, indicates a lower threshold that would result in lease modification accounting. Further, the FASB gives entities the option to assume that all lease concessions granted are lease modifications, so significant care should be given where lease payments increase on an undiscounted basis.  Evaluating lease classification If the entity concludes that the lease concessions have resulted in a lease modification, the entity must evaluate lease classification. There are a number of factors to consider in performing that evaluation. The fair market value of the asset is an important assumption required within that evaluation. Understanding the impact of COVID-19 and changing market conditions is essential to developing a reliable and supportable estimate of fair market value. There is significant evidence that asset values may already be declining as a result of changes in tenant credit quality as implied by the rent collection figures noted above. This is further evidenced by an elevated rate of canceled and re-traded deals. While the extent of the impact on fair market values is yet to be fully realized, more than 17% of commercial real estate deals that were scheduled to close in April were canceled in the first three weeks of the month. This is more than triple the previous full-quarter high of 5.6% in the first quarter of 2008 as the Great Recession was emerging. [2] Another factor affecting assumptions within the evaluation of lease classification includes rapidly shifting market conditions that could affect an entity’s incremental borrowing rate when measuring the right-of-use asset for a modified lease under Topic 842. In addition, declining operational performance could affect an entity’s credit rating, and shifting capital markets could significantly change the cost of borrowing for both lessors and lessees.  These factors combined create significant challenges in completing an evaluation of lease classification. A reliable evaluation increases the usefulness of avoiding lease modification accounting.  Portfolios and disclosures The FASB Q&A also addressed whether the accounting for lease concessions should be applied consistently across the entirety of a company’s lease portfolio. While there is no specific requirement, the FASB indicated that an entity should apply a consistent method to leases with similar characteristics and in similar circumstances.  Lastly, an entity should consider the impact to disclosures, making sure any material lease concessions, and the effects, are adequately described in the footnotes. Key considerations In conjunction to lease modifications, other things to consider that will influence lease treatments, include:  Lease or debt covenant violations Changes in incremental borrowing rates (IBRs) Lessee accounting Various ways to quantify the rates (economic factors, credit worthiness of company, etc.)  Changes in fair market value  Fair market value is a key variable for the finance versus operating lease testing where lessee would need market data and expertise in estimating fair market value For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.   [1] NAREIT survey of members and FTSE NAREIT All Equity REIT index equity market capitalization, FactSet, March 31, 2020  [2] Canceled Deals Surge During Pandemic, CoStar News, April 23, 2020 

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Coronavirus recovery and growth resources

Lease Accounting Readiness (ASC 842)

Understanding lease modifications resulting from the impact of COVID-19 

The spread of COVID-19 created major disruptions to economies around the globe, including the U.S., which at the time of this writing has more confirmed cases and deaths due to COVID-19 than any other country in the world. The severe, but necessary, reaction in the U.S. has been to enforce social distancing and shelter-in-place orders, which triggered an abrupt economic meltdown of unknown duration causing surging unemployment, declining stocks and uncertainty across all sectors. Real estate, with its inherent reliance on people congregating, be it in a restaurant, shopping center, apartment complex or office building, has been particularly affected. In this whitepaper you will learn: How economic disruptions, such as COVID-19, has hit certain real estate sectors harder than others The three-step process for impairment testing for long-lived assets Example tests to walk you through the testing process
For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.

Long-lived real estate asset impairment: testing and fair value measurement in response to COVID-19

In December 2019, Baker Tilly leaders Roger Ledbetter, Thane Hutcheson and Brent Maier were joined by Houston real estate industry specialists Sonya Rosenbach, CFO with Allied Orion Group, and Rene Joubert, principal with i3, for a panel discussion on real estate industry trends and opportunities. Bob Charlet, publisher of the Houston Business Journal served as moderator for the discussion. The group discussed topics ranging from recent trends in the real estate market to best practices for Opportunity Zones to overlooked funding sources.  Some real estate owners hold many assets and may not have expertise in-house to assess and monitor their portfolio’s performance. In the following exchange, the group provides insights on the pros and cons of relying on in-house performance measures as compared to outsourcing these to a third party. Brent: A major benefit of performing this function in-house is the cost avoidance by not having to compensate an outside advisor, the costs are fixed and you can perform the function internally. We have many clients with this expertise who are sophisticated investors and operators who perform these functions themselves.  There are other situations where companies may be spread thin due to a growing business, lack of expertise in a certain area, regulatory changes or changes in staffing. In those cases, outsourcing may make sense. For example, we’ve worked with a private equity firm that wants to get into a particular asset class, but doesn’t have the needed expertise. In a case like that, we are co-advising with the private equity firm where we have the industry experience and knowledge to assist with their decision making. The downside of internal performance measurement is the real or perceived lack of expertise in an area. In these cases, companies may have some of their staff who, instead of doing their “day job,” get distracted by working on other things outside their expertise. The advantage to hiring an advisor is that, with the right advisor, they've had experience in other situations they can draw on and relationships they can leverage to help get to a solution or an answer to a complex situation. The downside, of course, is the cost, but the benefit hopefully outweighs the cost.  Rene: An advisory firm is a fully integrated company, which helps them mitigate their own cycle risk for other lines of business income. However, our biggest focus is “know your asset.” From our standpoint, controlling your assets is critical to knowing how you're going to do on a long-term basis.  Sonya: Our team has extensive expertise in-house, but we also know when to call in other experts to help evaluate performance. We regularly interact with various third-party experts, multi-family professional organizations, and our peers, making sure that we're connected to what's going on in the industry. We collaborate often, but that doesn't always mean you hire a consultant – you can also collaborate without incurring extra costs. Brent: It goes back to our earlier conversation about collaborating and connecting to people. I think my job is pretty simple; it's just connecting dots. I think we're all in a similar program; just connecting dots.  Roger: This is a great time in the market with cap rate compression prices. Companies have to reevaluate whether to use advisors to review your portfolio and non-core assets or do this in-house. This may be a great time to divest. 
For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.

Baker Tilly leaders joined the Houston Business Journal for a discussion  on on the pros and cons of relying on in-house performance measures as  compared to outsourcing these to a third party.

Real estate portfolio performance: the pros and cons of in-house performance measures vs. outsourcing

Healthy market conditions in Houston and throughout the country have led  to continued strength in the commercial real estate market. During this  time of marketplace expansion, portfolio management remains important  to optimizing your real estate property. The elements and sub-elements  of your real estate portfolio need to be tailored and adjusted to meet  investor objectives and adapt to market conditions. Given today’s  conditions – and talks of a possible economic slowdown – what strategies  should be used to help ensure efficient use of capital and continued  opportunities to maximize investments? Baker Tilly leaders Roger Ledbetter, Thane Hutcheson and Brent Maier  were joined by Houston real estate industry specialists Sonya Rosenbach,  CFO with Allied Orion Group, and Rene Joubert, principal with i3, for a  panel discussion on real estate industry trends and opportunities with  the Houston Business Journal. Topics discussed include: Recent trends in the real estate market Minimizing exposure of assets and taking advantage of opportunities during economic uncertainty  Best practices for Opportunity Zones Real estate portfolio shifts Attracting tenants to properties Overlooked funding sources
Real estate portfolio performance: the pros and cons of in-house performance measures vs. outsourcing Monitoring and assessing real estate portfolio performance can be a  challenge for any real estate owner, especially those that hold many  assets. Deciding between in-house performance measures compared to  outsourcing to a third party can be a difficult decision for many  reasons, including cost, expertise and resources. 

In this  segment of the panel discussion, the same group provides insights on the  pros and cons of relying on in-house performance measures as compared  to outsourcing these to a third party. 

Baker Tilly leaders joined the Houston Business Journal for a dynamic  panel discussing trends and opportunities in today’s real estate market.

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Real estate outlook 2020: trends and opportunities

Providing real estate developers, owners, operators and investors with valuation and advisory services for real estate entities, property portfolios, and complex developments.

The need for specialized valuation services is ever increasing in today’s business and regulatory environment. The valuation of business interests and related assets in the context of company advisory, financial and tax reporting, portfolio valuation, estate planning, insurance valuation and due diligence is at the center of many important strategic and financial decisions, making the selection of a valuation consultant a critical choice. Baker Tilly’s dedication to all aspects of real estate valuation means you can count on our experience, knowledge and objectivity to address your business needs.

Real estate valuation is a complex and disciplined process that requires deep understanding of properties and broader market trends. Our real estate valuation and advisory services professionals work closely in the context of transactions on a regular basis, which allow them to apply holistic, strategic insight encompassing the entire transaction lifecycle.

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Our accurate and reliable real estate valuations paired with strategic advisory services encompass the entire transaction lifecycle.

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Real estate valuation and advisory services

Real Estate Valuation & Advisory Services

Commercial real estate market report: Q3 2020

Commercial real estate market report: Q2 2020

The Impact of COVID-19 on real estate valuation and leasing

Understanding lease modifications resulting from the impact of COVID-19

Long-lived real estate asset impairment: testing and fair value measurement in response to COVID-19

Real estate portfolio performance: the pros and cons of in-house performance measures vs. outsourcing

Real estate outlook 2020: trends and opportunities

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