Technical Line SEC staff guidance

Transcription

1 No Updated 27 August 2015 Technical Line SEC staff guidance How to apply S-X Rule 3-14 to real estate acquisitions In this issue: Overview... 1 Applicability of Rule Measuring significance... 3 Financial statement requirements.. 6 REIT formation transactions Blind pool offerings Acquisitions of properties subject to a triple net lease Properties securing mortgage loans Appendix A: Example Rule 3-14 financial statements Appendix B: Comparison of Rule 3-14 and Rule 3-05 requirements What you need to know The SEC staff s guidance for acquired real estate operations affects how registrants apply Rule 3-14 of Regulation S-X in determining whether audited financial statements of an acquired property are required. The determination of whether an acquired property qualifies as a real estate operation is essential in the application of Rule 3-14 and often requires judgment by management. Companies contemplating acquisitions of real estate or forming a real estate investment trust (REIT) should understand Rule 3-14 and the SEC staff s guidance. Overview Rule 3-14 of Regulation S-X (Rule 3-14) requires registrants to present the audited financial statements of significant consummated or probable acquisitions of real estate operations. These requirements differ significantly from those in Rule 3-05 of Regulation S-X (Rule 3-05), which addresses significant acquisitions of businesses. Although Rule 3-14 itself is rather brief, its application has been subject to various interpretations by the Securities and Exchange Commission (SEC) staff, preparers and their advisers over the years. The SEC staff s guidance is included in the Division of Corporation Finance s Financial Reporting Manual (FRM), 1 in Section 2300, Real Estate Acquisitions and Properties Securing Mortgages.

2 This Technical Line, which updates our earlier publication, provides information to help registrants interpret and apply Rule Specifically, we discuss determining whether an acquisition qualifies as a real estate operation, measuring significance and appropriately presenting financial information. We also discuss other types of property acquisitions covered by Rule 3-14 and the related SEC staff guidance, including: REIT formation transactions Blind pool offerings Properties subject to a triple net lease Properties securing mortgage loans that represent a significant asset concentration Applicability of Rule 3-14 Defining real estate operations Rule 3-14 applies to significant consummated and probable acquisitions of real estate operations that generate revenue through rental income. Acquisitions of commercial real estate, such as office or industrial buildings, apartment complexes and shopping centers, generally meet the criteria. Properties such as nursing homes, hotels, golf courses and auto dealerships generally do not qualify because leasing doesn t drive substantially all of their revenues. A registrant that acquires one of these properties generally applies Rule 3-05, which has a higher threshold for significance (20%) but requires more robust financial statements. The evaluation of whether Rule 3-14 or Rule 3-05 applies is separate and distinct from the determination of whether a business has been acquired under US GAAP (i.e., ASC 805, Business Combinations). Illustration 1 Evaluating real estate operations Scenario A Company Y acquires a senior residential living community, where residents live independently and require limited care by the staff. The property leases space to outside parties that operate a cafeteria and provide on-site medical services. The facility also operates a small convenience shop where residents can purchase snacks, beverages and sundry items. In the fiscal year before the acquisition, the community generated $5 million in rental revenues from residents and the cafeteria and medical operators. The community also generated $15,000 in revenue from the sale of items at the convenience shop. Analysis: The senior residential living community likely meets the definition of a real estate operation. Revenues generated by operations other than the leasing of real property were nominal in the fiscal year before the acquisition. Company Y could reach a different conclusion if the residential living community itself generated revenues by providing cafeteria and medical services in addition to leasing. Scenario B Company Z acquires a senior assisted-living facility, where all residents require regular care and assistance and are unable to prepare their own meals. The facility employs a team of in-house medical personnel and delivers three meals per day to residents. The facility generated $3 million in rental revenue from residents, $2 million in medical billings and $1 million from food service in the prior fiscal year. Analysis: The facility generated a significant portion of its revenues from operations other than the leasing of real estate. Therefore, the registrant would instead apply Rule 3-05 to this acquisition and provide full audited financial statements if significance exceeds 20%. 2 Technical Line How to apply S-X Rule 3-14 to real estate acquisitions Updated 27 August 2015

3 Registrants must apply Rule 3-14 if they acquire an equity interest in an existing or newly formed legal entity (e.g., a partnership, corporation, LLC) that will acquire properties under lease and the related mortgage debt in connection with, or soon after, the entity is formed. If the acquired entity engages in operations in addition to leasing, the registrant generally would apply Rule The staff has provided guidance for registrants to consider when they acquire a legal entity that has businesses in addition to real estate operations (e.g., property management). If such an acquisition is not significant under Rule 3-05 (i.e., the acquisition does not exceed 20% under any of the significance tests), the registrant should consider whether financial statements under Rule 3-14 might be necessary if the investment in the real estate is significant at a level greater than 10%. In other words, the registrant may not disregard the requirements of Rule 3-14 solely because an acquisition that is significant between 10% and 20% has operations other than leasing. The SEC staff will accept financial statements that comply with Rule 3-05 in lieu of Rule 3-14 financial statements for acquisitions of real estate operations that exceed the 10% threshold. How we see it Many operators of real estate assets seek to maximize the cash flows of a property by identifying and expanding ancillary sources of revenue. Although the determination of whether an acquisition qualifies as a real estate operation may initially appear to be straightforward, registrants must carefully evaluate all revenue sources to determine whether they are acquiring real estate operations, in which case Rule 3-14 would apply, or a business, in which case Rule 3-05 generally would apply. Measuring significance Because Rule 3-14 doesn t say how to calculate significance, the SEC staff provides guidelines in the FRM for calculating the significance of acquisitions of properties, both individually and in the aggregate. The staff also provides considerations that must be applied to certain circumstances arising from the acquisition of a real estate operation. Calculation of significance Significance is generally determined by comparing a registrant s investment in the property with the registrant s total assets as of the latest audited fiscal year-end. Properties that are related must be evaluated as a single acquisition. The SEC staff requires that the investment (numerator) include any debt secured by the property that is assumed by the purchaser. Illustration 2 Calculating significance Company A, a calendar-year registrant, acquires a fully occupied office building on 30 April 20X1. Company A paid cash consideration of $8 million and assumed existing mortgage debt secured by the property of $22 million. Company A s total assets at 31 December 20X0 were $250 million. Analysis: Company A s total investment in the office building of $30 million includes cash consideration paid and mortgage debt assumed. Because the investment exceeds 10% of Company A s total assets at 31 December 20X0 of $250 million, management would conclude that the acquisition was individually significant. Therefore, Company A would be required to file a Form 8-K within four business days of the acquisition and file audited Rule 3-14 financial statements and related pro forma information by amendment within 71 days from the due date of the Form 8-K. 3 Technical Line How to apply S-X Rule 3-14 to real estate acquisitions Updated 27 August 2015

4 Implementation considerations The SEC staff provides additional implementation guidance related to the timing of acquisitions: A registrant that has not completed its first full fiscal year should use total assets from the most recently audited balance sheet on file with the SEC as the denominator in the significance calculation. A registrant that completes an acquisition after its most recent fiscal year may evaluate significance based on the total assets of the recently completed fiscal year if it files its Form 10-K for that year before the due date of the Form 8-K/A to provide Rule 3-14 financial statements (including the 71-calendar-day extension). For purposes of a registration statement, the registrant must use the most recent audited financial statements on file as of the effective date. The SEC staff permits a registrant to evaluate significance under Rule 3-14 using pro forma financial information in a previously filed Form 8-K. A registrant that makes a real estate acquisition after providing financial statements of any individually significant business or real estate acquisition(s) on Form 8-K may evaluate significance using its pro forma total assets as of its most recently completed fiscal year-end presented in the Form 8-K that gives effect to the acquisition(s). The registrant must, however, exclude the pro forma effects of transactions that aren t significant acquisitions. The SEC staff expects registrants that use this approach to apply it consistently for the rest of the fiscal year. Illustration 3 Completing an acquisition after fiscal year-end Company B, a calendar-year registrant, completes an acquisition of a fully leased distribution facility on 4 January 20X2 for a total investment, including assumed debt, of $20 million. Company B s total assets for the period ended 31 December 20X0 were $190 million. Company B plans to file Form 10-K for the period ended 31 December 20X1 on 28 February 20X2 and will report total assets of $210 million as of the balance sheet date. Analysis: Company B must file a Form 8-K by 8 January 20X2 (within four business days) reporting the significant real estate acquisition. However, assuming Company B files its Form 10-K within the anticipated time frame, management may use total assets as of 31 December 20X1 to determine the significance of the acquired property. As a result, the acquisition would not meet the 10% threshold for individual significance based on total assets as of 31 December 20X1. Company B would not be required to provide Rule 3-14 financial statements on Form 8-K/A on or before the 71-calendar-day extension. Management of Company B must track subsequent acquisitions to determine whether those acquisitions, when combined with the acquisition described in this illustration, exceed the 10% threshold in the aggregate for the purposes of any registration statement (i.e., whether they exceed 10% of total assets at 31 December 20X1). 4 Technical Line How to apply S-X Rule 3-14 to real estate acquisitions Updated 27 August 2015

5 Illustration 4 Completing a subsequent acquisition after a significant acquisition Company C, a calendar-year registrant, completes an acquisition of a fully leased retail center on 31 July 20X2 for a total investment, including assumed debt, of $50 million. Company C s total assets for the period ended 31 December 20X1 were $475 million. On 15 February 20X2, Company C completed an acquisition with a total investment of $75 million. Company C provided Rule 3-14 financial statements for this acquisition on Form 8-K on 10 April 20X2. The pro forma financial information as of 31 December 20X1 reflected total assets of $550 million. Analysis: Company C is permitted to evaluate the significance of the $50 million acquisition on 31 July 20X2 using the pro forma total assets reported in the 10 April 20X2 Form 8-K filing. As a result, the acquisition would not meet the 10% threshold for individual significance, and Company C would not be required to file Form 8-K or Rule 3-14 financial statements. However, for purposes of any registration statement, management of Company C must track subsequent acquisitions to determine whether those acquisitions, combined with the $50 million acquisition described in this illustration, exceed the 10% threshold in the aggregate when compared with pro forma total assets at 31 December 20X1. Individually insignificant properties that meet the related property criteria must be evaluated for significance in the aggregate. Aggregation of individually insignificant properties A registrant must evaluate in the aggregate acquisitions of real estate operations that do not individually exceed 10% of total assets. If the combined investment in insignificant acquisitions exceeds the 10% threshold, a registrant is required to present Rule 3-14 financial statements for certain of the acquired operations if it files a registration or proxy statement. Audited financial information of acquired insignificant properties is not required to be filed in Form 8-K unless the properties are related. (See Contents of required financial statements section for the definition of related properties). To compute significance, registrants must combine the following: Individually insignificant properties acquired after the end of the most recently completed fiscal year for which the registrant s audited financial statements are on file Individually insignificant probable acquisitions Properties that, if individually significant, would not require financial statements under Rule 3-14, such as triple net leased and newly constructed properties, should be excluded from this computation. (See Acquisitions of properties subject to a triple net lease and Contents of required financial statements sections, respectively.) If the aggregate of all insignificant real estate properties exceeds the 10% threshold, the registrant must file audited financial statements for all acquisitions that individually equal or exceed the 5% threshold. Further, registrants should determine whether they have filed financial statements for individually insignificant acquisitions that together exceed 50% of the aggregate purchase price (including assumed debt). If this threshold is not met, the registrant should file financial statements of acquisitions that are individually insignificant below the 5% threshold until financial statements for more than 50% of the aggregate purchase price have been filed. Registrants that are unable to obtain audited financial information to comply with these requirements should request relief in writing from the Division of Corporation Finance s Office of the Chief Accountant. 5 Technical Line How to apply S-X Rule 3-14 to real estate acquisitions Updated 27 August 2015

6 How we see it Registrants that plan to file new registration statements, or update existing shelf registrations, should keep in mind the requirements of Rule 3-14 when negotiating the acquisitions of real estate properties. Companies often fail to consider the aggregation of individually insignificant properties and are unable to obtain the historical financial information necessary to comply with Rule 3-14 and meet their desired offering timetable. When a registrant believes Rule 3-14 financial statements may be required, management should try to negotiate into the purchase agreement access to historical financial records of the acquired property, especially for acquisitions for which the investment is greater than 5% of the acquirer s total assets. Illustration 5 Evaluating individually insignificant properties Company D, a calendar-year registrant, plans to file a registration statement on 9 July 20X2 and incorporate by reference its 20X1 Form 10-K. Throughout 20X1 and in 20X2 so far, Company D completed, or determined to be probable, the following acquisitions: 20X1 Acquisitions Significance 20X2 YTD Acquisitions Significance Probable Acquisitions Significance Property G Property H Property I 6% 3% 2% Property A Property B Property C 12% 2% 5% Property D Property E Property F 6% 4% 11% Analysis: Company D is not required to evaluate individually insignificant acquisitions that occurred in 20X1, thus Properties G-I are excluded from further evaluation. Because Property A exceeded 10% significance, audited Rule 3-14 financial statements were required to be filed in a Form 8-K and must be included or incorporated by reference in the registration statement. Because Property F exceeds 10% significance, its audited Rule 3-14 financial statements must be included in the registration statement. Properties B, C, D and E are individually insignificant because none exceeds 10%. In the aggregate, however, the acquisitions total 17%. As a result, Company D must present the financial statements of certain of these properties to comply with Rule Company D must provide financial statements of properties C and D because each individually exceeds the 5% threshold. The inclusion of these financial statements would provide Company D with greater than 50% coverage (5% + 6% = 11% / 17% = 64.7%) of individually insignificant acquisitions, thus the SEC staff would not object to the omission of financial statements of properties B and E from the registration statement. Financial statement requirements When to present Rule 3-14 financial statements Financial statements are required in the following filings for each acquired real estate property and probable acquisition that is significant, individually or in the aggregate: Proxy statements soliciting shareholders votes on the acquisition of real estate 1933 Act registration statements (e.g., Forms S-1, S-3, S-4, S-11, equivalent foreign forms) 1934 Act registration statements (e.g., Forms 10, 20-F) 6 Technical Line How to apply S-X Rule 3-14 to real estate acquisitions Updated 27 August 2015

7 Financial statements must be provided for each of the following acquisitions or probable acquisitions: Completed purchases of individually significant (greater than 10%) properties made during each year presented for which the registrant s financial statements have been filed All completed purchases of individually significant properties made after the end of the most recent fiscal year for which the registrant s financial statements have been filed Any probable acquisition of an individually significant property Completed or probable acquisitions of individually insignificant properties that are significant in the aggregate that occurred, or will occur, after the end of the most recent fiscal year for which the registrant s audited financial statements are on file (See Aggregation of individually insignificant properties section below for further discussion of related significance considerations.) The SEC staff has said that acquisitions during any period(s) for which financial statements are included or incorporated by reference into a registration statement are required to be assessed for significance under Rule That rule requires financial statements even for acquired properties that have been included in the registrant s audited financial statements for a full 12 months (e.g., properties acquired during the earliest two of the three years presented in the financial statements). As a result, previously filed financial statements provided under Rule 3-14 must continue to be included or incorporated by reference in registration statements until the property has been consolidated for all of the years for which the registrant s financial statements are presented. In contrast, Rule 3-05 does not require registrants to provide audited financial statements of an acquired entity that has been included in their audited financial statements for at least nine months (unless such financial statements have not been previously filed or the acquired business is of major significance). The SEC staff s view also applies to an initial public offering (IPO) registration statement. However, an emerging growth company (EGC) that elects to provide three years of its audited financial statements in an IPO registration statement may satisfy the Rule 3-14 requirements by providing financial statements of significant acquired properties acquired during the two most recent fiscal years and subsequent unaudited interim period. In IPOs, Staff Accounting Bulletin (SAB) Topic 1.J (SAB 80) permits the use of a modified significance test that can reduce the number of periods required for pre-acquisition financial statements of acquired businesses under Rule Such relief does not apply to significant acquired properties under Rule The SEC staff also has indicated that an acquisition is probable if the registrant s financial statements alone would not provide investors with adequate financial information with which to make an investment decision. All relevant facts and circumstances (e.g., imminence of consummation, materiality of transaction) should be considered in making this judgment. How we see it Generally, we believe an acquisition is probable if the parties have agreed in writing to the major provisions of the transaction. However, an agreement in principle also can lead to a conclusion that a future acquisition is probable. The SEC staff generally considers acquisitions probable if they are conditioned only upon obtaining financing or approval by shareholders or regulators or if they are disclosed in the registration statement. Management should consult legal counsel when evaluating whether acquisitions are probable. 7 Technical Line How to apply S-X Rule 3-14 to real estate acquisitions Updated 27 August 2015

8 A registration statement or post-effective amendment cannot be declared effective until financial statements for all acquisitions meeting the requirements of Rule 3-14 have been provided. While Rule 3-14 financial statements are not required before a company draws down on an active shelf registration, it must determine whether a significant acquisition, or a series of individually insignificant acquisitions, constitutes a fundamental change that would require a post-effective amendment to the registration statement. It is the responsibility of management to determine what constitutes a fundamental change, which has not been defined by the SEC. Additionally, the company should assess whether the absence of Rule 3-14 financial statements is a material omission from the prospectus supplement. How we see it Registrants that are nearing the deadline to update an expiring shelf registration should consider the timing of significant property acquisitions that must be reported on Form 8-K. We do not believe that an acquisition that meets the Rule 3-14 threshold automatically constitutes a fundamental change. Nor do we believe that acquisitions of individually insignificant real estate operations would likely constitute a fundamental change when aggregated. Form 8-K requires the reporting of acquisitions of individually significant properties under Item This requirement does not extend to acquisitions of individually insignificant properties unless the properties are related properties. While a significant acquisition must be reported four business days after it is consummated, registrants have an additional 71 calendar days to amend Form 8-K to include Rule 3-14 financial statements and associated pro forma financial information. Updated financial statements would not be required in the Form 8-K if substantially the same information was previously filed (e.g., when a registration statement previously included the financial statements of the property as a probable acquisition). The previously filed financial statements and pro forma financial information may be incorporated by reference into the Form 8-K filed in connection with the acquisition. Financial statements included in previous filings are generally considered to be substantially the same by the SEC staff unless the previously filed financial statements (1) would not satisfy the age requirements of Form 8-K because operating results for two or more interim quarters are omitted or (2) are interim financial statements and the Form 8-K requires updated audited annual financial statements. For purposes of Rule 3-14, the SEC staff has determined that properties are related, and therefore must be aggregated and treated as a single acquisition, if any of the following apply: The properties are under common control or management. The acquisition of one property is conditioned on the acquisition of each of the other properties. Each acquisition is conditioned on a single common event. The SEC staff has specifically stated that it does not consider the acquisition of real estate properties to be in the ordinary course of business for purposes of evaluating the applicability of Item 2.01 requirements of Form 8-K. The 74-day exception in Rule 3-05 (b)(4) for registration statements does not apply to the acquisition of real estate operating properties under Rule This exception grants registrants relief from providing Rule 3-05 financial information of an acquired business if (1) it is not significant at the 50% level and (2) the effective date of the prospectus, or mailing of the proxy statement, is no more than 74 days after the consummation of the business combination. 8 Technical Line How to apply S-X Rule 3-14 to real estate acquisitions Updated 27 August 2015

9 As a result, a registrant that has acquired a significant property must include those financial statements in the registration statement even if they are not yet due to be reported on Form 8-K. A registrant 2 must either provide the required financial statements within the applicable registration statement or, if permitted by the form, within a Form 8-K that is incorporated by reference into the registration statement as of its effective date. Contents of required financial statements While the significance thresholds mandated by Rule 3-14 are lower than those in Rule 3-05, the form and content of the required financial statements are generally less onerous. Rule 3-14 requires only audited income statements for the most recent fiscal year and the subsequent unaudited interim period if the property is acquired from an unrelated party. These statements should also exclude items that are not comparable to the proposed future operations of the property (e.g., mortgage interest, leasehold rental, depreciation, corporate expenses, federal and state income taxes). Properties are unrelated if the following conditions are met: The property is not acquired from a related party. Material factors considered by the registrant in assessing the property are disclosed in the filing, including sources of revenue and expense. The SEC staff provides registrants with relief for acquisitions with rental histories of less than a year. The registrant discloses any other material factors that would cause the reported financial information not to be indicative of future operating results. Otherwise, the registrant must provide Rule 3-14 financial statements for the three most recent fiscal years 3 and subsequent unaudited interim period (two most recent fiscal years and subsequent unaudited interim period for smaller reporting companies). The filings must contain financial statements for the properties for a full fiscal year before the acquisition. The SEC staff will not accept audited financial statements for a rolling 12-month period prior to acquisition in lieu of audited statements of the latest fiscal year of the property, nor will it accept audited financial statements for a period of nine to 12 months, which is permitted under Rule 3-06 for Rule 3-05 financial statements. In addition, pre- and post-acquisition periods cannot be combined to produce a full year of financial information. Therefore, it is possible that Rule 3-14 financial statements could be required for periods prior to those of the registrant s financial statements included in the registration statement. The requirements for updating Rule 3-14 financial statements are consistent with those of Rule For properties with limited rental history, the following relief is available: Registrants may request from the SEC staff relief from the audit requirement for financial statements of properties with a rental history of nine to 12 months. Relief from the audit requirement for financial statements of properties with a rental history of three to nine months is automatically available to the registrant. Financial statements are not required for a property with a rental history of less than three months. The SEC staff also does not object to the omission of financial statements of acquired real estate operations if the property will be demolished and replaced with a new rental property since the prior rental history would not be relevant. The registrant should explain the basis for omission of the financial statements within the relevant filing. When the registrant believes the leasing history of the acquired property does not reflect future utilization, the registrant may request relief in writing from the SEC staff. 9 Technical Line How to apply S-X Rule 3-14 to real estate acquisitions Updated 27 August 2015

10 See Appendix A for an example of an abbreviated income statement for an acquired real estate operation as required by Rule REIT formation transactions A newly formed REIT may acquire operating properties immediately before or in connection with the filing of an initial public offering (IPO) on Form S-11. The SEC staff allows these registrants to compute significance using a denominator that is the sum of the total investment in (1) properties acquired immediately before filing an IPO, (2) properties to be acquired immediately after filing an IPO and (3) probable acquisitions both at the date of the filing and at the effective date of the registration statement. Illustration 6 Measuring significance in a REIT formation transaction Company E, a newly formed REIT, filed an IPO registration statement on 9 July 20X2. The table below summarizes properties Company E acquired, or will acquire, from unrelated third parties throughout 20X2. For purposes of the example, properties acquired immediately before and in connection with the IPO have been combined and are reflected in Acquired properties. Acquired properties Cost Significance Property A $ 1m 4% Property B $ 6m 22% Property C $ 15m 54% Total Cost $ 27.5m Total Significance 100% To-be-acquired properties Cost Significance Property D $ 2m 7% Property E $ 2.5m 9% Property F $ 1m 4% Analysis: Because the significance of properties B and C individually exceed 10%, audited financial statements for each of these properties must be included in the IPO registration statement. Properties A, D, E and F are individually insignificant acquisitions because none exceeds 10%. In the aggregate, however, the acquisitions total 24%. As a result, Company E must present the financial statements of certain of these properties to comply with Rule Company E must provide financial statements of properties D and E because each individually exceeds the 5% threshold. The inclusion of these financial statements would provide Company E with greater than 50% coverage (7% + 9% = 16% / 24% = 66.7%) of individually insignificant acquisitions, thus the SEC staff would not object to the omission of financial statements of properties A and F from the IPO registration statement. Illustration 7 REIT formation transaction including related properties Assume the same facts as described in Illustration 6 above, except that properties D, E and F are under common management prior to acquisition. These properties therefore meet the related property criteria of Rule 3-14 and must be evaluated in the aggregate. Analysis: Properties D, E and F exceed the 10% threshold in the aggregate. Company E must include audited financial statements of these properties within the IPO registration statement. Company E may elect to provide financial statements for these three properties separately or on a combined basis. Because Property A is individually insignificant and is not related to properties D, E and F, financial statements of Property A are not required. 10 Technical Line How to apply S-X Rule 3-14 to real estate acquisitions Updated 27 August 2015

11 Measuring significance after an IPO In computing significance of any acquisition that was not contemplated at the IPO, a REIT may continue to use the asset base calculated in connection with its IPO until it files its first Form 10-K. The asset base should be reduced for any acquisition that has not occurred and is no longer probable. However, the asset base need not be reduced for probable acquisitions that were contemplated at the date of the IPO and continue to remain probable. Blind pool offerings A blind pool registration statement allows registrants to sell securities to purchase real estate operations that are not identified at the effective date of the registration statement. Item 20.D of SEC Industry Guide 5 requires that such registration statements include the following undertakings: The filing of a sticker supplement to the prospectus during the distribution period (i.e., the period during which the registrant is conducting a continuous 1933 Act registered offering) describing each property that has not been identified and disclosed previously whenever a reasonable probability exists that the property will be acquired The consolidation of all sticker supplements into a post-effective amendment filed at least once every three months during the distribution period. Such a post-effective amendment must include or incorporate by reference Rule 3-14 financial statements that have been filed, or should have been filed (considering the 71-calendar-day extension), on Form 8-K for all significant property acquisitions. Pro forma information is also required for any significant acquisitions for which Rule 3-14 financial statements are filed. However, unlike a post-effective amendment filed as a result of a fundamental change, financial statements of significant property acquisitions are not required in a post-effective amendment to consolidate sticker supplements if they have not yet been filed and are not yet required to be filed (considering the 71-calendar-day extension) in a Form 8-K. Also, unlike other post-effective amendments, a post-effective amendment to consolidate sticker supplements under the Industry Guide undertakings is not required to include Rule 3-14 financial statements of significant probable acquisitions or individually insignificant acquisitions even if they are significant in the aggregate. The prospectus updating regime in the Item 20.D undertakings is intended solely for real estate companies and not for other types of companies that may be subject to other parts of Industry Guide 5. Companies subject to the Item 20.D undertakings that acquire a property that generates significant revenues from operations other than leasing rental property should follow the Item 20.D updating regime discussed above, except that the significance thresholds and required financial statements should be those specified in Rule If the Rule 3-05 significance tests are not met, an acquisition with a rental history should then be evaluated under Rule Additionally, companies subject to the Item 20.D undertakings that acquire a triple net leased property also should follow the Item 20.D updating regime discussed above, except that the significance threshold applied and financial information provided should be those described in the Acquisitions of properties subject to a triple net lease section below. Measuring significance during the distribution period The method used by entities to compute significance of an acquisition during the distribution period applies to both acquisitions of regular operating properties and properties subject to triple net leases. 11 Technical Line How to apply S-X Rule 3-14 to real estate acquisitions Updated 27 August 2015

12 A registrant should measure significance during the distribution period by comparing the total investment in the property, including any debt assumed by the purchaser, with the sum of the following: The registrant s total assets as of the date of the acquisition Proceeds, net of commissions, in good faith expected to be raised in the registered offering over the next 12 months An individual property is considered significant if the investment exceeds the 10% threshold. Properties that are related or that were acquired from a single seller should be evaluated in the aggregate. Registrants also should evaluate whether a new triple net lease at an existing property creates a significant concentration of risk from the lessee. How we see it Common considerations when determining estimates of future proceeds include the pace of fundraising at the measurement date, the sponsor s prior public capital raising experience and recent offerings by similar registrants. To prepare for possible inquiries from the SEC staff, management should have evidence to support its assumptions, as well as documentation of its specific process for determining estimated proceeds. Distribution period reporting requirement Financial information of significant properties acquired during the blind pool distribution period should be provided in a current report on Form 8-K. Financial statements should comply with Rule 3-14 requirements and include pro forma information. Updated financial statements would not be required in the Form 8-K if substantially the same information was previous filed. (See When to present Rule 3-14 financial statements section.) Reporting acquisitions after the distribution period While companies do not file sticker supplements after the distribution period is completed, the requirement to include Rule 3-14 financial statements of significant acquired properties on Form 8-K remains in effect. Until a registrant files its first annual report after the distribution period ends, significance of an individually significant property should be computed by comparing the total investment in the property to the registrant s total assets as of the acquisition date. For any registration statements filed after the distribution period but before the next annual report is issued, registrants also must evaluate the aggregate significance of individually insignificant acquisitions made after the end of the distribution period. For this purpose, the registrant would compute significance based on assets as of the end of the distribution period, using either the pro forma total assets reported in its most recent Form 8-K filed during the distribution period or its total assets reported in its most recent interim period financial statements filed during the distribution period. Acquisitions of properties subject to a triple net lease Real estate companies frequently acquire properties subject to a triple net lease arrangement or enter into such arrangements in conjunction with a property acquisition (e.g., sale-leaseback transactions). In a triple net lease, the lessee is typically required to pay all costs associated with the ownership and operation of a property, including property taxes, insurance, utilities and maintenance. When a property is leased to a single lessee under a triple net lease, the rental payments by the single lessee likely represent the only cash inflows generated by the property. In addition, cash outflows from the lessor are typically limited to debt-service payments. As a result, the SEC staff determined that filing financial statements of properties under a triple net lease would not provide sufficient information to an investor given the registrant s underlying risk exposure to the lessee. 12 Technical Line How to apply S-X Rule 3-14 to real estate acquisitions Updated 27 August 2015

13 Therefore, when a registrant acquires a property subject to a triple net lease with a single tenant or enters into such a lease, and such properties represent a significant portion of the registrant s assets, the registrant is required to provide financial statements of the lessee(s) in lieu of financial statements of the operating property. This requirement also extends to co-lessees or guarantors of triple net lease arrangements. The SEC staff believes that a concentration of assets subject to a triple net lease with a single lessee (or guarantor) is significant if it exceeds 20% of the registrant s total assets as of its most recent balance sheet date. Measuring concentration significance The registrant should use the most recent balance sheet on file with the SEC, whether audited or unaudited, to measure the significance of a concentration of triple net leased assets. If a triple net lease property is acquired in connection with a blind pool offering, the registrant would add proceeds expected to be raised in the next 12 months to the total asset base as of the most recent balance sheet date. (Refer to the Blind pool offerings section above for further discussion of tests of significance for a blind pool offering.) Reporting requirements Registrants should consider significant asset concentrations when preparing registration statements under the 1933 and 1934 Acts, as well as when filing annual reports and current reports on Form 8-K resulting from a property acquisition. The registrant should provide full audited annual financial statements of the lessee or guarantor and the most recent and comparable interim financial statements for the periods required by Rules 3-01 and 3-02 or Rules 8-02 and 8-03 of Regulation S-X, as applicable, of Regulation S-X. 4 If the lessee or guarantor is a public company subject to the periodic reporting requirements of the 1934 Act, the registrant may include a reference to a publicly available website that contains the SEC-filed financial information of the lessee or guarantor. We believe, by analogy to Rule 3-09 of Regulation S-X, when the financial statements of the lessee or guarantor are not available by the due date of the registrant s Form 10-K, they may be filed in an amendment to Form 10-K by the due date of the lessee or guarantor financial statements (or when the financial statements would be due if the lessee or guarantor were a registrant based upon its filing status). A registrant should consult with the Division of Corporation Finance s Office of the Chief Accountant if it believes that less-detailed financial information is appropriate based on the particular facts and circumstances of the arrangement, or if financial statements of the lessee or guarantor are not available. How we see it Companies should keep in mind that they can exceed the threshold for concentration of significance of triple net leased assets by either acquiring a new real estate asset or signing a new lease at an existing property. Management should monitor all relationships with tenants (or guarantors) that have the potential to represent a significant concentration upon the consummation of a new acquisition or signing a new lease. Privately held tenants or guarantors may resist providing financial information for inclusion in a registrant s SEC filings. As a result, when negotiating triple net lease arrangements, companies should consider obligating tenants or guarantors to help them fulfill any current or future SEC financial reporting obligations that arise under the lease. 13 Technical Line How to apply S-X Rule 3-14 to real estate acquisitions Updated 27 August 2015

14 Illustration 8 Acquisition of property subject to triple net lease Company F acquired an office building from Company Q, a nonpublic company, on 9 July 20X2 for cash consideration of $125 million. Following the transaction, Company F leased the office building back to Company Q for a term of 10 years. In addition, Company F transferred substantially all of the property s nonfinancial holding and operating costs to Company Q. Furthermore, Guarantor P, also a nonpublic company, agreed to guarantee Company Q s net rental payment to Company F. At 31 December 20X1, Company F had total assets of $450 million. Analysis: Because the significance of the acquired property exceeded 20% ($125 million/ $450 million = 28%), Company F must comply with Form 8-K reporting requirements resulting from the property acquisition and provide the audited financial statements of Guarantor P for the three years ended 31 December 20X1 and for the three-month periods ended 31 March 20X2 and 20X1. If Guarantor P were a public company, the Form 8-K would be required to include only a reference to a website that contains Guarantor P s SEC filings. In addition, audited financial statements of Guarantor P should be included in Company F s 20X2 Form 10-K and any registration statements. Specifically, Company F s 20X2 Form 10-K should include audited financial statements of Guarantor P as of 31 December 20X2 and 20X1 and for each of the three years in the period ended 31 December 20X2. If Guarantor P were a public company, the Form 10-K would be required to include only a reference to a website that contains Guarantor P s SEC filings. If Guarantor P had not guaranteed Company Q s rental payments, audited financial statements of Company Q would be required instead. Significance between 10% and 20% A registrant may acquire a property subject to a triple net lease that doesn t exceed the 20% concentration threshold but does exceed the 10% threshold under Rule The SEC staff s published guidance clarifies that in these circumstances, registrants must provide audited financial statements of the acquired property that comply with the requirements of Rule The SEC staff also will accept audited financial statements of the lessee(s) in lieu of audited financial statements of the acquired property. In either case, the Form 8-K must include pro forma financial information reflecting the transaction. How we see it Rule 3-14 financial statements provided when the significance of a triple net leased property acquisition exceeds 10% but not 20% could be limited to the presentation of only a single line of rental revenues. Property operating expenses are generally paid by the lessee in a triple net lease arrangement, and Rule 3-14 excludes from the presentation historical activities that may not be indicative of future operations (e.g., mortgage interest, depreciation, corporate expenses). 14 Technical Line How to apply S-X Rule 3-14 to real estate acquisitions Updated 27 August 2015

15 Properties securing mortgage loans Acquisition, development and construction (ADC) arrangements A registrant may originate a mortgage loan that is secured by a real estate operating property that in substance represents an investment in real estate or a joint venture rather than a loan. These loans may constitute an ADC arrangement as described in ASC 310, Receivables. ADC arrangements may have some of the following characteristics: The lender participates in expected residual profits. The lender provides all of the cash flows to acquire and complete the project, including agreeing to the addition of interest to the loan balance rather than receiving payment from the borrower. The lender is able to look only to the property itself to recover the loan. The borrower is not at risk through guarantees or pledging other collateral, nor are there unconditional contracts with third parties that ensure recovery of the loan. The lender s ability to recover principal and interest depends solely on the sale of the property or the obtaining of permanent financing from another independent source. SAB Topic 1.I. 5 states that financial statements are required under Rule 3-14 for such properties that secure loan arrangements that meet the definition of an ADC arrangement under ASC Act financial statement requirements Financial statements of operating properties securing ADC loans are required in all 1933 Act registration statements for any single property that is 10% of the greater of offering proceeds or total assets at the latest year-end balance sheet. The information required by Items 14 and 15 of Form S-11 also should be included with respect to these investment type arrangements. However, if no single loan exceeds 10%, but the aggregate of such loans exceeds 20%, a description of the general character of the properties and arrangements is required in a note to the financial statements. Such information may include a description of the terms of the arrangements, participation by the registrant in expected residual profits and property types and locations Act financial statement requirements Annual reports on Form 10-K must include the following financial information for operating properties securing ADC loans: If more than 20% of the registrant s total assets are invested in a single loan, financial statements of the underlying operating property are required (except in annual reports to shareholders where only summary data is required). If more than 10% but less than 20% of the registrant s total assets is invested in a single loan, summarized financial information of the operating property is required. When individual loans are not significant but in the aggregate exceed 20% of the registrant s total assets, a description of the properties and arrangements is required in a footnote to the financial statements. Entering into a significant ADC arrangement (i.e., greater than 10% significant) also triggers a requirement to file a timely Form 8-K with financial information for the underlying operating property. 15 Technical Line How to apply S-X Rule 3-14 to real estate acquisitions Updated 27 August 2015