REITs: New Rules Needlessly Complicate Rental-Income Accounting

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By Denise Lugo

Fourteen real estate investment trusts (REITs)—including Boston Properties, Kilroy Realty Corp. and Forest City Realty Trust Inc.—say new revenue and lease accounting rules will bring burdensome and costly changes to how they report rent collected from multifamily apartment complexes.

“It wouldn’t rightly reflect current business practice for how those rental contracts are drawn up and would be burdensome to implement because there’s nowhere in the contract that says we know what the fee for the maintenance is,” Charles Obert, executive vice president, chief accounting officer and corporate controller at Forest City Realty Trust Inc., told Bloomberg Tax.

It is unclear whether the new accounting changes provide any benefit to investors, and the significant costs REITs would incur to comply with them wouldn’t be justified, the companies said.

Seeking Exceptions to Standards

The companies have asked the Financial Accounting Standards Board to provide implementation guidance so REITs won’t have to comply with portions of the standards that would require them to change the way they account for income earned from leased apartments.

The new revenue rules are effective in January for public companies. They eliminate all industry specific accounting rules and establishes a five-step model for reporting revenue. The leases standard is effective 2019, but a number of companies will adopt it next year with the revenue rules.

Lease accounting changes affect mostly lessees, requiring them for the first time to put on balance sheets leased assets and leased liabilities they previously could keep off them. Fewer changes are required for lessors.

For some larger REITs the process will require evaluation of more than 50,000 leases and splitting them up to reflect items that are inherent in a lease, but aren’t negotiated separately from it.

Each apartment might have multiple roommates and usage each month said a Sept. 29 letter to FASB signed by accounting chiefs from Apartment Investment and Management Co., BSR Trust, LLC, Camden Property Trust, Equity Residential, LEDIC Realty Company, LLC, Mid-America Apartment Communities, Inc., UDR, Inc., AvalonBay Communities, Inc., and Forest City Realty Trust, Inc.

The new accounting rules require REITs to split out community amenities such as on-site fitness centers or maintenance services like snow removal from walk ways—and report them separately from base rent on the income statement.

REIT investors currently use gross rent in a lease in evaluating the quality of revenue earned and haven’t actively requested any break-out.

Today, landlords don’t differentiate these items as they are all considered one performance obligation under the lease. “Right now let’s say we charged $1000 a month for a particular lease, it would show up in our financial statements as rent for $1000,” Obert said.

“But what this new pronouncement says is ‘go in and estimate how much of this $1000 is really your providing maintenance services and, or, amenities to your client,’"he said.

Two Sets of Books

The changes also would require “lessors of office real estate to maintain two sets of accounting records, one for how we manage and operate our businesses and another one to meet the accounting and reporting requirements” of ASC 842, Leases and ASC 606, Revenue from Contracts with Customers, said a Sept. 28 joint letter to FASB from Boston Properties, Kilroy Realty Corp., Vornado Realty Trust, SL Green Realty Corp. and Alexander’s, Inc.

Companies also worry that the allocation of maintenance and amenity components, which aren’t a core part of their business streams, might bring unnecessary scrutiny from federal, state and local tax authorities as well as inquiries and audits regarding the qualification of REIT status under the Internal Revenue Code of 1986.

“What the fear is, is that somebody’s going to come in and say ‘oh you misstated how much is the common area maintenance versus how much is the amenities versus how much is the rent,” said Obert. “Whereas if you just put it all as rent, there is no debate about it.”

Current reporting requirements are an easily supportable measure that investors, regulators and auditors and the overall marketplace understands, Overt said. “Why spend significant time and effort to change this to a bunch of tough-to-support estimates that may not even be used by everyone?” he said.

Today under multifamily residential leases, residents have a 12-month lease, inherent in which is both the apartment and the requirement that the lessor support the general upkeep of the apartment community for a fixed monthly fee.

The leases are structured to include all expenses: usage of the apartment unit, executory costs such as real estate taxes and insurance, maintenance activities, and community amenities.

Community amenities may include the use of the on-site fitness centers, pools, clubhouses or other gathering centers, dog parks, and play grounds. The companies also maintain apartment complex landscapes, parking lots, and walk way snow removal and cleaning and maintenance of other community amenities.

“If they have to bifurcate rent and community maintenance activity fees across hundreds or thousands of leases, they would have to add headcount or contract with a consultant like an accounting firm or some other kind of consulting firm to get this done,” Matt Waters, Lease Accounting Specialist at CoStar Real Estate Manager, the lease management software division of CoStar Group Inc., told Bloomberg Tax.

“Smaller companies would add head count, large companies might have to add a department that focuses on this—this would be a pretty time intensive and man power intensive type of exercise,” Waters said.

To contact the reporter on this story: Denise Lugo in New York at dlugo@bna.com

To contact the editor responsible for this story: S. Ali Sartipzadeh at asartipzadeh@bna.com

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