Pros and Cons of Investment Property Componentization
January 3, 2000
Mr. Roy Rendino
Chairman, Cost Capitalization Task Force
AICPA Accounting Standards Executive Committee
c/o Prime Group Realty Trust
77 West Wacker Drive
Chicago, Illinois 60601
Re: Pros and Cons of Investment Property Componentization
Dear Mr. Rendino:
The National Association of Real Estate Investment Trusts (NAREIT) is pleased to have the opportunity to provide the Accounting Standards Executive Committee's (AcSEC) Cost Capitalization Task Force information regarding the pros and cons of investment property componentization. As you know, NAREIT is the national trade association for REITs and publicly traded real estate companies. Members include real estate investment trusts (REITs) and other businesses that develop, own, operate, and finance income-producing real estate, as well as those firms and individuals who advise, study, and service these businesses.
The business of developing, owning and operating investment property regularly involves the acquisition and development of assets. In this context, the accounting standards for capitalizing the cost of these assets are important to producing useful financial reports for publicly traded real estate companies.
NAREIT has formed a Cost Capitalization Task Force to review and respond to the activities of the AcSEC task force. Pursuant to your request, attached is a list of "pros and cons" regarding the issue of componentization. Notwithstanding this list, NAREIT strongly believes that the attention and focus on the primary purpose of the AcSEC task force (i.e., what costs should be capitalized) should not be diluted by the componentization question. By focusing on the development of guidelines for the capitalization of certain items considered to be "gray areas," comparability within the industry could be enhanced. However, there are numerous issues, both theoretical and practical, that would need to be resolved before implementation of new guidelines would be appropriate.
Further, we do not believe that the AcSEC task force should consider componentization of the costs of investment property unless it is prepared to consider the depreciable lives of the components. Current methods of measuring investment property depreciation expense result in an overstatement of this charge to periodic earnings. Componentizing the costs without considering the depreciable life of each component may exacerbate this situation.
Finally, the AICPA task force should consider that the International Accounting Standards Committee (IASC) is moving toward an investment property model with less componentization than currently exists under the historical cost model now used under U.S. GAAP. The IASC is considering fair value accounting for investment property that would combine land and building into one component. This suggests that now may not be the time to consider additional componentization since the international model is heading in the other direction.
NAREIT appreciates the opportunity to participate in the AcSEC's considerations with respect to cost capitalization. If you should have any questions regarding our comments, please contact George Yungmann at (202) 739-9432, David Taube at (202) 739-9442, or me at (484) 530-1888.
Timothy A. Peterson
Executive Vice President and Chief Financial Officer, Keystone Property Trust
Co-Chair, NAREIT Accounting Committee
May enhance the uniformity of capitalization practices.
May result in more accurate useful lives, and therefore a more appropriate depreciation charge for investment property if componentization results in extended lives for the long-lived portion of the asset and a longer weighted-average life for the total asset.
Would facilitate the removal of the cost and related accumulated depreciation of portions of the asset which are replaced or fully depreciated
May provide useful information for analysis by generating more relevant information concerning short-term cash needs for capital maintenance. Cons:
May exacerbate the excessive depreciation charge required under current GAAP for investment property if componentization results in a shorter weighted-average life for the total property.
Level of detail - May be onerous and costly to companies if they are required to componentize assets into many parts. The benefits of componentization may not outweigh the costs.
Would not be practical to apply componentization retroactively, thereby impacting consistency and comparability of financial statements. Completing cost segregation studies on thousands of properties is not a feasible solution to this problem.
Would cause further comparison issues between the financial statements of acquirers and developers because of the differences in availability of information for componentization. Again, completing cost segregation studies on all acquisitions is not a feasible solution to this problem.
May create less uniformity in practice because of the increase in the number of factors used to measure aggregate depreciation cost. Increasing the number of estimates used in the calculation of depreciation may increase the variability of the calculation. This may impact the comparability of the financial statements with regard to the amount of depreciation expense. Further, the increased factors may result in increased costs due to additional audit effort and possibly the use of additional experts - appraisers, engineers, etc.