Fair Valuing Assets in Real Estate: Purchase Price Allocation and Impairment

The Importance of Fair Valuing Assets in Real Estate  

Real estate organizations wrestle to make sense of the current market challenges  by interest rates, supply and demand, credit availability, and lender restrictions. As such, a crucial area for real estate owners to consider is the fair value of their assets. In real estate audits, the fair value of assets plays a critical role in purchase price allocations (PPA) and impairment analysis.  

Given the current economic environment, there will be more scrutiny on organizations' underlying calculations to arrive at an asset's fair value.  

Understanding the Approaches to Valuing Real Estate 

When valuing real estate, there are three accepted approaches to consider: the market approach, the income approach, and the cost approach. The real estate market has been relatively volatile over the past few years, so it's important to review appraisals received. 

Market Approach 

The market approach, also known as the sale comparison approach, utilizes third-party appraisers to conduct a valuation by comparing a property to the values of recently sold properties in the area. When using this approach, one must consider the quality of the market data obtained.

When analyzing the market data, focus on qualitative characteristics and comparable assets to determine if the market is appropriate for the valuation of the asset. Depending on external factors, the market could inflate or deflate its value. It’s important to also analyze and project future trends that could impact on the value of the appraisal.  

Income Approach 

The income approach involves developing a model to value the future cash flows of the property. With this method, it's important to evaluate the various inputs used in the calculation and be mindful of the volatility of cap rates in the current market.

In addition to reviewing all your input and completing calculations, one must evaluate whether the value is reasonable or will fall on the sale as too conservative or aggressive. Real estate owners need to make sure they can support their property’s valuation position taken in the current market.  

Cost Approach 

The cost approach estimates a property’s value by considering the cost of building an equivalent property. In other words, the fair market value is the amount it would cost to replace or replicate the property.  

The cost approach calculates property value as the cost of the land plus the cost of construction minus depreciation. This can be less accurate than other methods for three reasons:    

• If the market value of a property has changed significantly since the original purchase.,  
• It assumes that a buyer can find a vacant plot of land to build an identical property.   
• It can be difficult to estimate the depreciation of older properties.  

Purchase Price Allocation (PPA) 

Once an asset is purchased the fair market value is used during PPA to record and account for the acquisition of a property. 

The ASC 805 applies to all transactions where an entity obtains control of one or more businesses, including mergers, and provides guidance on how to account for the purchase of an entity. As such, the PPA would include all identifiable assets (including fixed assets), and liabilities acquired. Under ASC 805, the purchase price of an acquisition is allocated to the assets acquired and liabilities assumed at fair value, with limited exceptions.    

Impairment of Assets 

Once the fair market value is determined, the value is then used during an audit for an impairment analysis. An impairment analysis determines if the carrying amount of an asset exceeds its fair value. Under ASC 360, numerous triggering events could be indicators of an impairment of an asset (or asset group), such as: 

• A significant decrease in the market price of a long-lived asset (or asset group).
• A significant adverse change in the extent or way a long-lived asset (or asset group) is being used or in its physical condition.
• A significant adverse change in the legal factors or in the business climate that could affect the value of a long-lived asset (or asset group), including adverse action or assessment by a regulator.
• An accumulation of costs significantly more than the amount originally expected for the acquisition or construction of a long-lived asset (or asset group).
• A current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset (or asset group).
• A current expectation that, more likely than not, a long-lived asset (or asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. (The term “more likely than not” refers to a level of likelihood that is more than 50%.) 

If there is an impairment, ASC 360-10 provides accounting guidance for the impairment of assets held for use, held for sale, and to be disposed of by other means. Under GAAP, assets impairment is calculated by:  

• Taking the asset’s carrying value (historical cost minus accumulated depreciation).
• Subtracting the asset’s fair market value from the carrying value.
• If the fair market value is lower than the carrying value, recording the difference as an impairment loss. This means you: 

• • Debit the impairment loss expense on the income statement. 
  • Credit the fixed asset account on the balance sheet. 

The details of the impairment loss must then be disclosed in the financial statement footnotes.

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As companies continue to face economic uncertainty, real estate owners fair asset value real estate owners should assess their fair asset value, reevaluate purchase allocations, perform a thorough impairment analysis, and reassess their accounting for any impairments recorded. Contact EisnerAmper if you have questions about fair asset value, purchase price, or impairment.