ASC Topic 946: Scope Exception for REITs

Debt and equity real estate private equity funds typically follow specific accounting rules for investment companies, as outlined in ASC Topic 946 Financial Services – Investment Companies.

However, real estate funds organized as a real estate investment trust, or REIT, have a scope exception under ASC 946-10-15-3.

Fund managers and administrators that are considering organizing their next fund as a REIT need to understand the financial reporting implications. Unlike investment company accounting, which reports investments at fair value and recognizes unrealized and realized gains and losses, REITs report their individual assets and liabilities and recognize their operating revenues and expenses.

Below is a non-exhaustive list of accounting treatments to consider for equity and debt funds.

Equity Funds

Equity funds have balance sheets with land and building, offset by mortgage payable. Their income statements include rental income, operating expenses, and interest expenses.

Upon acquisition, the property assigns value to its acquired tangible and intangible assets and assumed liabilities in accordance with ASC 805 – Business Combinations.

Real estate acquisitions typically fall under the asset acquisition model, where a purchase price allocation will assign value to assets such as:

• Land
• Building
• Site improvements
• Tenant improvements
• In-place lease costs
• Above market leases

They will also assign value to liabilities such as below-market leases and assumed mortgage premium based on their relative fair values.

Real estate assets are reported at historical cost, depreciated over their useful lives, and reviewed for impairment.

The mortgage is reported as a liability, net of any unamortized deferred financing costs in accordance with ASC 835. Interest rate caps and swaps are reported at their fair value, following derivative accounting under ASC 815.

Rental income consists of minimum base rent, straight-line rent adjustments, amortization of tenant inducements, and amortization of above- and below-market in-place leases. ASC 842 – Leases requires recognizing base rent evenly over the lease terms and evaluating, on an individual lease basis, whether it is probable to collect. When the collectability assessment is deemed constrained, adjustments are recognized to rental income and future rental income is limited to cash received.

Costs incurred due to the execution of a lease, such as lease commissions, are capitalized and amortized over the term of the lease. Costs that are not dependent on the lease execution, such as legal fees, are expensed.

Debt Funds

Debt funds have balance sheets with loans receivable and equity method investments, offset by lines of credit or loans payable. Their income statements include interest income, investment income, operating expenses, and interest expense.

The balance sheet reports loans held for investment as loans receivable at the amortized cost basis, which includes:

• Origination or acquisition value
• Deferred origination fees and costs
• Premium or discount
• Accrued interest
• Accretion
• Amortization less cash received

Under ASC 310, loan origination fees should be net with any loan origination costs and amortized over the life of the loan as a component of interest income, following the interest method described in ASC 835.

Loans held for investment are subject to the current expected credit losses (“CECL”) impairment model under ASC 326, which requires the immediate recognition of estimated expected credit losses.

A debt fund, depending on its investment structure, may have to consider whether consolidation or equity method accounting applies.

What to Consider Before Launching Your Fund as A REIT

Fund managers and administrators need to understand the reporting requirements when organizing their fund as a REIT and how they differ from investment company accounting. It’s important to consult with an accountant before launching the fund to make sure they have a proper setup for reporting and managing investor expectations.