By Stephen H. Berardi
The Daily Record Newswire
Commercial real estate companies (such as property developers, owners, investors, managers and lenders) face unique income tax, development, accounting and financial reporting issues. The best source for expert solutions to these issues are accounting firms that provide traditional accounting services as well as specialized experience in such areas as due diligence procedures, cost segregation studies and business valuation services.
Traditional services
At a minimum, a commercial real estate company should make sure that its accounting firm is familiar with income tax and financial reporting requirements relating to real estate, including complex income-recognition issues. In addition, there are proposed new accounting rules for operating leases which will significantly change the way both lessors and lessees account for and disclose their operating leases.
Ideally, the accounting firm should have experience with the specific types of real estate and transactions that make up the core of the client's business. Many real estate professionals may not be familiar with the three types of reports that can be issued by an accounting firm to comply with financial reporting requirements. The three types are as follows:
- An audit is the highest level of assurance and is required for public companies and many privately-held companies in connection with financing or shareholder arrangements.
- The next level is a reviewed financial statement, which primarily includes applying analytical review procedures to management's financial data and making inquiries of company management. Reviewed financial statements are common for many closely held partnerships and less complex corporate structures.
- The third level is a compiled financial statement in which the accounting firm does not provide any level of assurance. It is normally used for closely held organizations with less stringent loan covenants relating to financial reporting.
During the past year, the AICPA, American Institute of Certified Public Accountants, has made several major changes applicable to compilation and review engagements including the establishment of a framework for the performance and reporting on compilations and reviews.
Value-added services
Real estate companies today expect much more from an accounting firm than the services listed above. Summarized below are some of the "value-added" services that real estate firms look for from their accounting firm:
- Business valuations;
- Detailed corporate and individual tax planning projections, along with estate tax planning services;
- Budgeting and reforecasting services to help companies prepare their annual operating and capital budgets. In addition, some companies will need updates to the operating budget at least once during the year to help compare the actual year-to-date results to the budget projections;
- Cost segregation studies to identify all construction-related costs that qualify for shorter federal tax lives. The result of reducing tax lives from 39 years (using straight-line depreciation) to 5, 7 or 15 years (using accelerated methods) can have a significant impact on a firm's federal tax liability and current cash flows; and
- Assistance in sale-leaseback transactions in which the owner sells property and simultaneously leases it back from the buyer.
Other services
Due diligence services in connection with property acquisition, financing or valuation has become a particularly important activity by accounting firms. Property-level due diligence consists of procedures for establishing "stabilized" results used to determine the value of the property in making the investment or lending decision. Such services typically include:
- Analysis of the historical operating results for the property to identify trends and provide explanations for variances between periods.
- Agreed-upon procedures report relating to the Statement of Actual Costs for a project.
- Review of leases and other agreements with tenants to identify certain key provisions such as the exact term of the lease, base rent, escalation provisions, contingent rental information (percentage rents), and concessions (e.g., tenant improvement allowances, rental abatements).
- Detailed review of rent escalation provisions to be sure that all rent increases are being billed to the tenants on a timely basis.
- Comparison of rental and vacancy rates relative to the market, and the operating results to published industry averages and comparable properties.
- Detailed review of rent escalation provisions to be sure they are being correctly accounted for under the tax and financial reporting rules.
- Visits to the property to study the site, competitive properties and the neighborhood.
At some point throughout the business cycle of a real estate investor, you will encounter a need for each of the services outlined in this article. It is most advantageous for one to hire an accounting professional who possesses the experience and skills to respond to these industry specific needs - whether the skills include traditional accounting services or "value-added"/non-traditional services. Ask questions up front to save time and dollars down the road.
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Stephen H. Berardi, CPA, is a principal at Mengel, Metzger, Barr & Co. LLP and can be reached at (585) 423-1860 or SBerardi@mmb-co.com.
Published: Mon, Apr 13, 2015
