Financial Regulatory Forum

ANALYSIS-Fair-value accounting may be coming for real estate

By Reuters Staff
November 2, 2010

By Dena Aubin

NEW YORK, Nov 2 (Reuters) – U.S. rule-makers are mulling an expansion of fair-value accounting to land and buildings held for investment, a change that could reshape the balance sheets of hundreds of real estate companies.

Fair value, which measures assets by their market worth rather than historical cost, is at the center of a big debate in the banking sector, where the Financial Accounting Standards Board is broadening its use.

The board has tentatively decided to also require fair value for investment property, potentially changing the way that hundreds of billions of dollars of commercial real estate are accounted for.

Companies likely to be most affected include real estate investment trusts, which own about $500 billion of commercial property, according to the National Association of Real Estate Investment Trusts (NAREIT), a trade association.

Under current generally accepted accounting principles, REITs value their buildings based on historic costs, depreciated each year. That method has long been criticized as giving an unrealistic value for real estate, which usually appreciates over time, despite its recent severe slump.

“I have heard people say if we report fair value, the information is more timely and transparent,” said George Yungmann of NAREIT. The trade group is not advocating fair value but is giving FASB its input, he said.

Publicly traded REITs such as Simon Property Group, Boston Properties and Vornado Realty Trust, along with REIT mutual funds, have become a growing asset class and are one of the only ways ordinary investors have to invest in large commercial properties.

PROPOSAL EXPECTED EARLY 2011

A draft fair-value rule for investment properties is expected early next year, according to FASB. No implementation date has been set.

The impact on companies’ balance sheets would depend on the age of their properties, industry experts said. Some REITs have property that has been depreciated since the 1980s, and the value of those assets would be significantly stepped up, said Tom Wilkin, a real estate partner at PwC.

“Other assets that were bought at the peak of the market, maybe in 2006 or 2007, might have significant declines in value that haven’t been recorded because they are not considered impaired,” he said.

The proposed change is part of FASB’s efforts to align U.S. accounting with International Financial Reporting Standards, set by the London-based International Accounting Standards Board. FASB’s rule is expected to be similar to International Accounting Standard 40, which allows a fair-value option.

If FASB follows that standard, changes in real estate value would be recognized in net income.

While FASB has not yet defined which companies its rule would apply to, REITs, real estate operating companies and other companies that hold property for capital appreciation or rent could be affected, according to PwC.

NO COST OPTION PLANNED

FASB’s proposed approach would differ from the international standard, which gives companies the option of using fair-value or cost accounting. FASB has tentatively decided that fair value would be required.

One impact could be a more timely picture of commercial real estate values. In the United Kingdom, where market values for real estate have been reported for years, prices of commercial property corrected during the recent downturn much sooner than they did in the United States.

Analysts said it is too soon to tell how fair value would affect REITs’ share prices or some of the complicated measures used to value REITs.

Net asset value, a common benchmark for valuing REIT shares, already incorporates a rough estimate of the market value of REIT assets and may not change much, analysts said. NAV is essentially the current value of a REIT’s assets, minus its liabilities.

Companies’ reaction to fair value is guarded, PwC’s Wilkin said.

“I think they’re comfortable to a large degree with where they are,” Wilkin said. “There are certain aspects of accounting today that they don’t like. This would fix it, but ‘is it worth the change?’ is I guess the concern.” (Reporting by Dena Aubin; additional reporting by Ilaina Jonas, editing by Matthew Lewis)

((dena.aubin@thomsonreuters.com; + 1 646-223-6325; Reuters Messaging: dena.aubin.reuters.com@reuters.net))

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