Speaker Bios. Brian Ruben Partner Deloitte & Touche LLP 111 S. Wacker Drive Chicago, IL

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1 Speaker Bios Brian Ruben Partner Deloitte & Touche LLP 111 S. Wacker Drive Chicago, IL Brian has over 19 years of public accounting experience serving real estate clients ranging from small private companies to publicly traded and multinational clients. He leads our national non-listed REIT practice and is a member of our U.S. Real Estate leadership team. Brian has significant experience serving real estate REITs (publicly traded, non-listed, private), partnerships, investment managers, property managers, institutional advisors, developers, homebuilders, and public pension advisors. He has substantial experience in fund formation, fair value accounting, IFRS, Securities and Exchange Commission matters, mergers and acquisitions services, and accounting and tax consultations. He has participated in numerous financing transactions, including public stock and debt offerings. Brian currently serves as the Midwest real estate industry learning leader for the audit practice and was co-author to two point of view articles entitled What is the value of my real estate? and Financial institutions: converting commercial mortgages to REO-valuation and accounting considerations. Representative Clients Served: AMLI Residential Properties Blackstone EPN Investment Management General Growth Properties, Inc. JLL/LaSalle Investment Management MASSPRIM Miller Capital Advisory Morgan Stanley Phillips Edison ARC Shopping Center REIT Inc. Retail Properties of America, Inc. Weingarten Realty Investors

2 Speaker Bios Patrick Scheibel Senior Manager Deloitte & Touche LLP 111 S. Wacker Drive Chicago, IL Patrick has over nine years of public accounting experience. In Chicago, Patrick serves primarily real estate clients, most notably General Growth Properties, Inc., Retail Properties of America, Inc, and Pearlmark Real Estate Partners. Patrick is also actively involved in Deloitte s national real estate practice, helping to lead practice-wide calls and webcasts on real estate-related matters. Prior to moving to Chicago in June 2012, Patrick was on assignment in Deloitte s National Office, working with Deloitte s real estate industry Professional Practice Director, Chris Dubrowski. In this role, Patrick served as a National Office subject matter resource for all industry related accounting and auditing consultations, developed content for and spoke at real estate industry conferences, assisted in the development of industry related accounting publications, and participated in the quality review of several of our largest real estate clients. Representative Clients Served: Cole Credit Property Trust General Growth Properties, Inc. HCP, Inc. Morgan Stanley Pearlmark Real Estate Partners Retail Properties of America, Inc. Starwood Realty Trust Vornado

3 Agenda Standards Setting FASB Projects SEC Comments on Real Estate Companies 3

4 Disclaimer This presentation does not provide official Deloitte & Touche LLP interpretive accounting guidance The views expressed are solely those of the presenter and are not formal Deloitte & Touche LLP positions Check with a qualified advisor before taking any action See slides at the end for additional resources available on these topics 4

5 Standards Setting Where are we at and where are we going?

6 Convergence Challenges Public Feedback on Incorporating IFRS Consistent views Largely supportive of the SEC s approach and IFRS as the single global accounting standard Strong FASB role Retaining US GAAP reference to ease contractual and regulatory burdens Establish criteria or threshold for modifications from IFRS Divergent views Single date verses staggered adoption Adoption timetable Retrospective or prospective adoption of new standards Option to early adopt Concerns raised Inconsistent interpretation and enforcement by regulators/auditors IASB independence, funding and due process Reluctance of IASB to issue interpretative guidance Impact on specialized industry guidance with no IFRS equivalent Smaller registrants concerned with resources and cost Litigation risks should be evaluated 6

7 Project Timeline: Joint Projects Expected date Projects Converged? Leases Partially E Revenue Recognition Yes FF/FI Financial instruments: Impairment Classification and Measurement Hedge accounting General (IASB) Hedge accounting Macro (IASB) No Partially N/A N/A E E RD/FI E Investment Companies/Entities No FI FF Consolidation (IASB standard issued in 2011) Partially FF E Exposure Draft RD Review Draft FF Final FASB FI Final IASB 7

8 FASB only Projects Projects Expected date Financial Instruments: Liquidity & Interest Rate Disclosures Liquidation Basis of Accounting Going Concern Transfers and Servicing: Repurchase Agreements H1 H2 H1 E (June) E (July) E E Investment Property Entities (IPE) E (Oct) O Definition of a Nonpublic Entity Disclosure Framework D (July) D (July) E Exposure Draft Final Final Standard D Discussion Memo O On Hold 8

9 FASB Done Deals

10 Fair Value Measurement

11 Fair Value Measurement Final standard (ASU ) issued May 12, 2011 Effective dates (calendar year-end entities): Public entities: Q Non-public entities: Year end 2012 Primary objective: Align the words in US GAAP and IFRS Secondary objectives to: Clarify and refine the measurement principles in Topic 820, and Expand disclosure requirements (of course!) The ASU does not change: When fair value measurements are required or permitted The fundamental fair value measurement principles Exit price Market participant viewpoint 11

12 Fair Value Disclosure Requirements Before After Transfers between Level 1 and Level 2 Only significant transfers were required All transfers should be disclosed Not required for non-public entities Highest and best use of a nonfinancial asset differs from its current use No requirement to disclose situations when an entity s current use of an asset differs from its highest and best use Disclosure is now required Fair value measurements that are only disclosed (e.g. FV of debt) No requirement to provide the level in the fair value hierarchy Must disclose the level in the fair value hierarchy Amended to not be required for non-public entities 12

13 Fair Value Disclosure Requirements (cont.) Before After New Level 3 disclosure requirements No requirement to disclose quantitative information about inputs Required to disclose quantitative information about inputs (e.g. cap rates, discount rates, market rent assumptions, etc ) No requirement to disclose a description of the valuation process used by the entity Required to disclose a description of the valuation process used by the entity No requirement to describe the sensitivity of Level 3 inputs or any related interrelationships Required to provide a narrative description of the sensitivity and any related interrelationships (not required for non-public entities) 13

14 Valuation Process Implementation Guidance Information about the group responsible for the reporting entity s valuation policies and procedures: I. Its description II. To whom that group reports III. The internal reporting procedures in place The frequency and methods for calibration, back testing, and other testing procedures of pricing models The process for analyzing changes in fair value measurements from period to period How the reporting entity determined that thirdparty information, such as broker quotes or pricing services, used in the fair value measurement was developed in accordance with Topic 820 The methods used to develop and substantiate the unobservable inputs used in a fair value measurement 14

15 Disclosure of Inputs for Level 3 FV Measurements Property Type Fair Value Real Estate Properties: Residential $ 259,670,000 Valuation Technique(s) Discounted cash flows (DCF) Direct capitalization method Unobservable Inputs Ranges (Weighted Average) Discount rate 12.1% to 24.3% (14.6%) Capitalization rate 3.4% to 10.7% (6.9%) DCF term (years) 10 years (10 years) Revenue growth 0% to 11.2% (4.1%) rate Direct cap rate 5.5% to 9.1% (7.5%) Office $ 89,323,000 Discounted cash flows Discount rate 9.5% to 21.2% (12.3%) Capitalization rate 3.0% to 12.1% (5.4%) DCF term (years) 10 years (8 years) Revenue growth rate 1.1% to 8.4% (6.1%) 15

16 FASB Projects Impacting the Real Estate Industry

17 Investment Property Entities

18 FASB Investment Properties Project IAS 40 gives option to carry investment properties at FV through income FASB s original thinking (summer of 2010): Convergence would be nice, so Let s issue guidance similar to IAS 40 (asset- based scope), but Make it a requirement, not an option Significant pushback from non-real estate companies holding investment properties Guidance as proposed: Scope was entity based, not asset based Investment Property Entities own investment property, carry at FV Modeled off the current definition of an investment company 18

19 Update on FASB Investment Properties Project In August 2012, the Board decided that it would not continue to develop the investment property entity concept Rather, once it completes certain other related projects, the Board will decide whether to pursue an asset-based approach for measuring investment properties that is similar to the approach in IAS 40, Investment Property If the Board decides to pursue such an approach, it would then decide whether fair value measurement should be an option or a requirement 19

20 Investment Companies/ Entities

21 Overview Joint project to provide comprehensive guidance for assessing whether an entity is an investment company/entity for accounting purposes Has nothing to do with regulatory classification (e.g Act) Will amend definition, provide measurement requirements and additional disclosures Exposure draft issued October 21, 2011 (in conjunction with the investment property entity exposure draft) IASB issued final guidance October 2012, effective January 1, 2014 FASB expected issuance first half of

22 Definition and typical characteristics of an investment company Required Attributes Obtains funds from an investor(s) and provides professional investment management service Business purposes & substantive activities are to invest funds for returns from capital appreciation, investment income, or both Investment Company Do not obtain benefits from their investments that are either: Other than capital appreciation or investment income Not available to other noninvestors / not normally attributable to ownership interests Additional characteristics (Not required to meet all of these criteria) Multiple investments Multiple investors Unrelated investors Equity or partnership interests Manages and evaluates its investments on a fair value basis 22

23 Latest Update on Project The FASB decided that the project will be now in two phases Phase 1 Issuance of the revised definition and certain disclosure requirements. Retains the REIT scope exception All REITs (Equity REITs and Mortgage REITs) will be scoped out of the revised definition. Phase 2 Separate project to evaluate accounting for investments in real estate in the context of investment companies. Convergence issue Non-investment company parent accounting for its investment in an investment company. US GAAP retain fair value accounting IFRS consolidate all subsidiaries, impose parent company accounting. 23

24 Leases 24

25 Lease Project Timeline Issued in August 2010 Original Exposure Draft (ED) Comment period ended December 2010 Over 750 letters received Redeliberations Revised ED expected 1 st Quarter of 2013 Final Standard Expected to be issued 2013 Effective Date Expected to be no sooner than

26 Lessee Accounting Right-of-use (ROU) model Initial measurement ROU asset PV of lease payments + lessee s initial direct costs Lease liability PV of lease payments Discount rate: Rate lessor is charging lessee if readily available; otherwise, lessee s incremental borrowing rate Subsequent measurement ROU asset Amortized cost: Method of amortization depends on nature of underlying asset (see slides that follow) Impairment: Refer to existing standards (ASC 360, IAS 36) Lease liability Amortized cost: effective interest method 26

27 Lessee Accounting ROU model s income statement effect Constituents concern about income statement effect being inconsistent with lease economics 27

28 Lessee Accounting Expense recognition A lessee s determination of the appropriate expense recognition pattern would be based on whether the lessee acquires and consumes more than an insignificant portion of the underlying asset Yes Is the leased asset property? No Lease term a major portion of asset economic life OR PV of fixed lease payments accounts for substantially all of the FV Lease term is insignificant to asset economic life OR PV of fixed lease payments insignificant relative to asset FV? Yes No Yes No Financing Approach Straight-line Approach Straight-line Approach Financing Approach 28

29 Two Subsequent Measurement Models for Lessees 29

30 Lessors of Real Estate The Journey Continues New Property and Leases with 'Insignificant Consumption' Scope Out from R&R Tenative Decision: July 2012 FAS 13 - Operating Lease Accounting November 1976 Investment Property Scoped Out from R&R Tenative Decision: October 2011 Performance Obligation Exposure Draft (August 2010) Receivable and Residual ("R&R") Tenative Decision: July 2011 "Other Than Financing" Model Tenative Decision: March

31 Lessor Accounting Receivable/Residual method or operating lease A lessor s determination of the appropriate expense recognition pattern would be based on whether the lessee acquires and consumes more than an insignificant portion of the underlying asset Yes Is the leased asset property? No Lease term a major portion of asset economic life OR PV of fixed lease payments accounts for substantially all of the FV? Lease term is insignificant to asset economic life OR PV of fixed lease payments insignificant relative to asset FV? Yes No Yes No Receivable/ Residual Method Operating Lease Operating Lease Receivable/ Residual Method 31

32 The Receivable and Residual Approach Similar to lessee model Derecognize underlying asset Replace with: Receivable (PV of lease payments) Residual asset Upfront profit 32

33 Revenue Recognition

34 Timeline and Recent Developments Month/Year June 2010 June 2011 Milestone Initial exposure draft issued Final decision by Boards to re-expose Q Issued revised exposure draft on 11/14/2011 with a 120 day comment period Q Q Q Q First half 2013 Perform outreach activities Evaluate feedback, perform public outreach, and finalize redeliberations Finalized revenue standard anticipated Effective date: Public Companies: No earlier than January 1, 2015 Non-public companies: One year later than public companies (January 1, 2016) Full retrospective application may be required 34

35 Key Concepts in the Exposure Draft Transfer of Control Performance Obligations One Size Fits All Question: Can a one size fits all model work for everyone? 35

36 Core Principle and Steps in the Model Core principle: Recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled in exchange for those goods or services Step 1 Identify the contract with a customer Step 2 Identify the separate performance obligations in the contract Step 3 Determine the transaction price Step 4 Allocate the transaction price to the separate performance obligations Step 5 Recognize revenue when (or as) the entity satisfies a performance obligation 36

37 Potential Effects on Real Estate Elimination of bright-line tests Can we look to the old (industry specific) rules to supplement the new rules? The board would not expect accounting firms to be developing guidance based on old GAAP to supplement the new [revenue recognition] standard. Leslie Seidman, FASB Chairman Prescriptive guidance provided by ASC (Sales of Real Estate) and ASC 605 (Construction) will be lost: Buyer s financial commitment - Guarantee buyer return Collectability of transaction price - Partial sales Continuing involvement by seller - Condominium sales Sales to limited partnerships/joint ventures - Sale-leaseback transactions 37

38 Potential Effects on Real Estate Elimination of bright-line tests Has the buyer made an adequate initial and continuing investment? Are you reasonably assured that the buyer is committed and will pay? Use of judgment when evaluating continuing involvement Continuing involvement is replaced with transfer of control and separate performance obligations Identify performance obligations (liabilities): property management services, commitments to support operations, development commitments Allocate revenue to each of the performance obligations; recognize revenue when performance obligations are completed 38

39 Potential Effects on Real Estate Use of judgment and reduced emphasis on collectibility How will this change conclusions related to real estate transactions? Will likely result in more transactions qualifying as sales of real estate with gains being accelerated Transactions that include contingent proceeds (often considered continuing involvement) may qualify for sales recognition Example 1 participation in future profits from a sold property if reasonably assured to be entitled Example 2 guarantees of certain future operating levels by the seller would not preclude sales recognition. Account for portion of sales proceeds separately Collectibility would affect the amount of gain or loss, not recognition, of revenue Boards still analyzing approaches to accounting for buyer credit risk 39

40 Consolidation Principal vs. Agent

41 FASB Principal vs. Agent: Overview Contains a single model for qualitatively assessing whether a decision maker (or general partner) is a principal or agent of the other stakeholders When assessing whether the reporting entity has the power to direct the most significant activities of the VIE that most impact the VIE s economic performance in ASC 810, the reporting entity would need to evaluate its decision-making authority as a principal or an agent. Proposal would revise the definitions of participating rights and kickout rights and would align the analysis of theses rights under variable interest entities, voting interest entities, and partnership models Would eliminate the deferral from Statement 167 for certain investment fund advisors 41

42 FASB Principal vs. Agent: Factors to Consider Rights held by other parties (including kick-out and participating rights) Substantive participating rights held by other parties are an indicator that the decision maker is an agent Substantive kick-out rights held by a single party would be conclusive decision maker is an agent Removal rights requiring the agreement of multiple parties (including BOD) may still be considered substantive but would not, in isolation, allow a general partner to conclude that it is an agent of the limited partners. As number of multiple parties required to come together to exercise removal rights increases, the likelihood that those rights would be substantive decreases 42

43 FASB Principal vs. Agent: Factors to Consider The decision maker s compensation Is the compensation of the decision maker commensurate with the services provided? Exposure to variability in returns from other interests (including rights held by related parties) Magnitude and variability associated with the decision maker s economic interests (e.g., investments and guarantees) Is there exposure to both positive and negative returns? An interest that only exposes the decision maker to positive returns would be less indicative of a principal relationship 43

44 Other Pending FASB Projects 44

45 Classification and Measurement of Financial Instruments Financial liabilities Amortized cost* * With certain exceptions Assess business model SPPI Financial assets Assess cash flows SPPI = Solely payments of principal and interest Not SPPI Do not assess business model Held to collect: Amortized cost Hold & sell: FV-OCI FV-NI (residual) FV-NI 45

46 Liquidity and Interest Rate Risk Disclosures Scope: All entities to provide footnote disclosures about liquidity risk, and Only financial institutions (including mortgage REITS) required to provide disclosures about interest rate risk Qualitative Disclosures The exposure to risks and how they arise Objectives, policies, and processes for managing risks and the methods used to measure the risks Quantitative Disclosures Cash flow obligations table Available liquid funds Interest rate sensitivity Is this stuff going to be auditable? 46

47 Discontinued operations Project objective To improve the definition and reporting of discontinued operations Converges with IFRS Raises the threshold for reporting disc ops The component or group of components is part of a single coordinated plan to dispose of a separate major line of business, or A separate major geographical area of operations Timing Exposure draft issued on April 2, 2013 Excellent news for real estate companies 47

48 Liquidation Basis of Accounting and Going Concern Phase I: Liquidation Basis of Accounting Purpose: Determine how and when an entity should apply the liquidation basis of accounting Conclusion: Prepare financial statements on the going concern basis unless liquidation is imminent When an entity s liquidation are consistent with those "contemplated in the entity's governing documents, a limited-life entity (like a real estate fund) should not use the liquidation basis of accounting 48

49 The Liquidation Basis of Accounting and Going Concern Phase II: Going Concern January 11, 2012, the Board tentatively decided not to require management to perform a going-concern assessment May 2, 2012: FASB decided to start a new project to revisit a requirement for management to assess an entity s ability to continue as a going concern The Board will consider feedback received during redeliberations on the liquidation basis of accounting 49

50 Small GAAP vs. Big GAAP

51 Private Company Council In May 2012 the FAF (FASB s parent foundation) decided to establish a Private Company Council (PCC) The FAF trustees will appoint 9 to 12 members to the PCC Board members must have private company experience and will represent various groups, including users, preparers, and auditors Responsibilities of the PCC: Advise the FASB on how private companies should treat current pending projects Determine whether exceptions or modifications to existing U.S. GAAP would benefit private company financial statement users The FASB still has the final say All exceptions and modifications proposed by the PCC would be subject to FASB ratification This is similar to how the EITF functions 51

52 AICPA s Financial Reporting Framework for Small and Medium-Sized Entities Stakeholders of smaller entities looking for an alternative to GAAP that is less complicated and costly Highlights: Far fewer items reported at fair value No items of other comprehensive income Goodwill and intangibles are amortized Impairment losses can be reversed Can elect proportional consolidation, equity or cost method for joint ventures Follow GAAP for transactions not addressed, or choose accounting not contemplated in any existing framework Will likely result in diversity in practice, even in the same industry This is not GAAP and would not be used if planning public offering Exposure draft issued November 1, 2012 for comments 52

53 SEC Comments on Real Estate Companies

54 MD&A Best Practices Use plain English and tables; avoid jargon whenever possible Describe only key changes in an overview section; avoid background information Focus on matters that are likely to have a material impact Monitor competitors disclosures and any associated SEC staff comments Ensure that the question why is answered; tell your story Avoid boilerplate risk factors Evaluate whether multiple factors are driving a change and quantify each factor Consider year-over-year comparison tables 54

55 Non-GAAP Measures We note your use of Core FFO within your earnings release. Please tell us whether management considers Core FFO to be a key performance indicator. If so, please include the disclosure of Core FFO within your next periodic report, providing the required disclosures pursuant to Item 10(e) of Regulation S-K. Please clarify that you use the NAREIT definition of FFO. We note your reference to an increase in same-property NOI. Please revise your disclosure to disclose in detail how same-property NOI is defined. 55

56 Lease Expirations and Leasing and Rental Trends In future periodic reports, for your retail and office properties, please provide a schedule of lease expirations for each of the ten years, starting with the current or next fiscal year, that includes the number of tenants or leases that will expire, the total area in square feet covered by such leases, annual rental represented by the expiring leases and the percentage of gross annual rental represented by such leases. We note that you disclose average rental rate per unit and average base rent per leased square foot. In future periodic filings, please include disclosure that clarifies how these amounts are calculated. 56

57 Development Activity We note your disclosure regarding your future development activity. To the extent that your future development activity is material, please disclose the anticipated completion date and budgeted costs for such activity In future filings please expand your disclosure in MD&A to include additional analysis of your capital expenditures breaking them down between new development, redevelopment/renovations, and other capital expenditures by year Please disclose the cash outflows from real estate acquisitions, development, and lease costs separately for each year presented in your statement of cash flows. 57

58 Capitalization Period We note that you capitalize development costs incurred during the construction period. Please tell us and expand disclosures in future periodic filings to discuss when this construction period begins and ends. We note that you have disclosed that construction and carrying costs are capitalized until the apartment homes are substantially completed. Please tell us, and disclose as part of your significant accounting policies and critical accounting policies in future filings, when the capitalization period begins and how that is determined. 58

59 Acquisition Costs Geography We note your response to comment in our letter dated relating to the presentation of acquisition costs below real estate operating income. Given the nature of your business and your history of making acquisitions we continue to believe that the presentation of acquisition costs in real estate operating income is appropriate. Please revise your presentation in future filings. 59

60 Held For Sale Criteria We note that you sold XX properties during the first quarter and that you have concluded that the properties did not meet the criteria to be classified as held for sale as of December 31, XX. Please explain to us in further detail how you determined that these properties did not meet the held for sale criteria at year end. Tell us the operating income for these properties that would have been classified as discontinued operations if the properties had been classified as held for sale. 60

61 Consolidation We note that you have a 51% ownership in an unconsolidated real estate limited partnership. Please tell us how you determined that this partnership should not be consolidated. You disclose you have an 83.55% economic ownership of XX Apartments, and that you account for this investment using the equity method. Please provide us with a detailed analysis and your basis in GAAP for using the equity method of accounting for this entity. 61

62 Loss Contingencies We note that XX has claimed damages of at least $YY million against you, plus attorney s fees. It is not clear whether $YY million represents your best estimate of reasonably possible loss, or the low end of a range of reasonably possible loss. Please revise your disclosure to disclose the range of reasonably possible loss in excess of amounts accrued, or a statement that such an estimate cannot be made. 62

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