Erika Morphy is co-editor of Debt and Equity Journal, from which this article is excerpted.
Norwalk, CT—For the first time, a REIT that holds assets in a JV can elect to value those assets at a "fair value" accounting standard. The rule is effective with an entity's first fiscal year that begins after Nov. 15, 2007, according to the Financial Accounting Standard Board's recent statement on the Fair Value Option for Financial Assets and Financial Liabilities, better known as FASB 159. In certain circumstances, the standard could be adopted even earlier.
Anecdotal observations, though, suggest few REITs plan to take FASB up on the offer in the near future. In theory, the presumption is that fair value exceeds book value, so a REIT's borrowing power would increase with fair value accounting. "It's one possible route for REITs to increase leverage," says Steven Marks, managing director and REIT group head for Fitch Ratings.
As Fitch explains in a recent alert, although equity interests in JVs are generally viewed as a leverageable asset class, it is recognized that covenants in standard REIT unsecured bond indentures allow REITs to borrow based on the aggregate accounting value of most assets in their portfolios, including equity interests."Therefore, REITs opting to report equity investments at fair value could experience a widening gap between borrowing capacity before and after the change in accounting measurement from 'at equity' to fair value," the rating agency concludes.
Yet to date, no REIT with assets in a JV has elected 159, Marks says, adding that he doesn't know of any that plan to either. Despite the increase in borrowing power, there are many reasons why a REIT would opt to stick with its old accounting methodology. "It can be a time consuming and money consuming exercise to compute and companies may not want to go down that route. It is also permanent so every year the company would have to go through fair valuing of assets," Marks says.
Rating agencies, as well, will be examining any change in status. "We would be concerned if there was a material increase in the ability to lever, says Fitch Rating's Sean Pattap. "We have to be comfortable with the company's assumptions on fair valuations."
Also, says Olu Sonola, in the same Fitch group, it is only a theoretical possibility that leverage could increase with 159. "We are not 100% sure that 159 will result in more leverage. No companies have adopted it yet, so we have not yet observed real cases."
George Yungmann, senior vice president, financial standards at the National Association of Real Estate Investment Trusts in Washington, DC, also is dubious that many REITs will opt for 159 at this point--but for different reasons. "It is only a partial step to fair value reporting," he says. Meanwhile, FASB is considering converging with IAS 40, which would allow for full fair value reporting of investment property and more REITs are inclined to wait to see if that comes to fruition. "In fact I know of one REIT which indicated it would not want to do this at this time, because it is only a partial reporting," he says.
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Erika Morphy
Erika Morphy has been writing about commercial real estate at GlobeSt.com for more than ten years, covering the capital markets, the Mid-Atlantic region and national topics. She's a nerd so favorite examples of the former include accounting standards, Basel III and what Congress is brewing.
