The Importance of Addressing Going Concern for Maturing Debt

Understanding the Context of a Going Concern Disclosure 

While a going concern disclosure might seem alarming, it’s important to understand that it doesn’t mean a company will not survive. In many cases, it’s a precautionary measure that allows investors and creditors to make informed decisions. For example, a property’s mortgage loan is due to mature within the next year. 

It’s important to consider the context of the disclosure. If a company has a high NOI, positive cash flow from operations, and a low LTV, a going concern disclosure, while significant, is not as alarming as an entity with break-even NOI, minimal cash flow from operations and are highly leveraged.  

There is no certainty a property will be able to refinance its mortgage loan in today’s debt market. Interest rates and lending requirements have likely changed since the property’s last financing. Having transparent disclosures will protect the entity and its stakeholders. 

What is the Going Concern Assumption?  

According to U.S. GAAP, management must evaluate if conditions or events could threaten an entity’s ability to continue operations within a year. In other words, can an entity meet its obligations as they become due for at least one year from the issuance of the entity’s financial statements.  

Entities with loans maturing within twelve months of their audit fall within this scope and may require going concern language in their financial statements. 

Why do Maturing Loans Raise Substantial Doubt? 

Many real estate owners have a history of obtaining financing, but rising interest rates, stricter lending requirements, and uncertain property valuations make refinancing more difficult. Predicting market conditions in the near future further complicates the process.  

Does the property generate sufficient cash flow to cover higher interest payments? Will the lender require a principal paydown? Is an interest rate cap required? Does the entity have the means to cover these costs, or is additional capital available? 

Can Management Alleviate the Substantial Doubt?  

To mitigate substantial doubt, management must demonstrate a strong likelihood of refinancing, paying down, or paying off the loan. This could involve securing a term sheet or providing personal guarantees.  

Typically, the maturity date is too far from when the financial statements are issued to obtain sufficient audit evidence from the lender that it can be refinanced, and an owner may not have the ability and intent to pay down or pay off the loan when it matures.  

The Impact on Financial Reporting  

When substantial doubt has been alleviated, the entity must disclose the conditions that raised concern, its evaluation of their significance, and its plans to address them. 

If substantial doubt cannot be alleviated, the entity must include a statement in the financial statements indicating substantial doubt about its ability to continue as a going concern, along with the principal conditions or events that raised concern, its evaluation of their significance, and its mitigation plans.  

Long-Term Implications of a Going Concern Designation 

Users of financial statements typically understand the circumstances surrounding a going concern disclosure, especially when it relates to refinancing a mortgage. The disclosure is often a one-time event, as the loan is expected to be refinanced before the following year’s financial statements are issued.  

Proactive Steps for Managing Going Concerns for Real Estate Owners  

Despite a strong rent roll, property location, or investor support, the uncertainty in the debt market makes it crucial for real estate owners to assess their upcoming loan maturities.  

Real estate owners and operators should identify any loans coming due within twelve months of the date the upcoming financial statements are expected to be issued and discuss whether this triggers substantial doubt about the entity’s ability to continue as a going concern. By addressing the issue early, all options are available for an appropriate disclosure, protecting the entity and its stakeholders. 

If you have going concern questions, connect with our team using the form below.