NAREIT Submission to FASB on Leases
August 8, 2000
Mr. Timothy S. Lucas
Director of Research and Technical Activities
Financial Accounting Standards Board
401 Merritt 7
P.O. Box 5116
Norwalk, CT 06856-5116
Re: G4+1 Special Report - Leases: Implementation of a New Approach
Dear Mr. Lucas:
The National Association of Real Estate Investment Trusts (NAREIT) is pleased to have the opportunity to respond to the Financial Accounting Standards Board's (the Board) Special Report on leases. NAREIT is the national trade association for real estate investment trusts (REITs) and other publicly traded real estate companies. Members include 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.
General Comments
The business of developing, owning and operating income-producing property requires ongoing leasing of space to generate income. At any time, many of our member companies are lessors in hundreds or, in most cases, thousands of leases. In this context, the accounting standards for leases are of vital importance to producing useful and relevant financial reports for publicly traded real estate companies.
NAREIT supports the Board's efforts to enhance the usefulness and relevance of financial reporting by developing international consensus on financial standards. However, as discussed below, we do not believe the recommendations in the Special Report regarding lessor accounting for land and buildings (investment property) would provide additional relevant information on financial statements of real estate companies. Our comments are based on the assumption that land and buildings subject to leases would be defined as investment property under International Accounting Standard (IAS) No. 40, Investment Property.
The recommended approach would require lessors to calculate the fair value of each lease contract on an ongoing basis. This would not be practical from a cost-benefit standpoint, as it would result in a huge expense for information that would be of little benefit and at best duplicative. Investors and analysts value investment property based on the net cash flow generated after consideration of expenses required to operate and maintain the property as a whole. Companies regularly utilize the equity value (fair value in excess of debt) of investment property to raise capital through sale or financing. Fair value of individual leases generally is not considered by financial statement users and is largely irrelevant.
The fair value of investment property provides financial statement users a more substantive understanding about the financial position of companies in making decisions about sale or financing transactions. Reporting the fair market value of the investment property as a whole is a more relevant measurement than simply reporting the fair value of the minimum rental payments required by the lease(s).
The recommended approach is especially inappropriate for companies that already report investment property at fair value. In March 2000, the International Accounting Standards Committee (IASC) adopted IAS 40, Investment Property, permitting fair value reporting for investment property. Significantly, although the standard provides a "free choice" between fair value and historical cost reporting, companies that choose the historical cost basis (IAS 16, Property, Plant and Equipment) are required to provide a footnote disclosure of the fair value of investment property. We believe there would be no additional benefit or relevance to segregate receivables from leases if the entity already reports the entire asset at fair value. Moreover, real estate companies are a party to hundreds or thousands of individual leases. To require that they be separately measured at fair value is not practical from a cost-benefit standpoint - again, especially if this value is already reflected in the fair value of an investment property.
NAREIT applauded the IASC's issuance of a policy governing the accounting for investment property that could produce more useful financial reports for real estate companies. In the US, generally accepted accounting principles (GAAP) require that investment property be carried on the balance sheet on a historical cost basis. Moreover, NAREIT believes that current depreciation practice results in an excessive charge to earnings on the statement of operations. The combination of these practices leads to overstated reserves (understated net assets) on the balance sheet and a potential overstatement of gain (or understatement of loss) upon disposition of the property. Because the resulting net income alone is generally not accepted within the investment community as a meaningful performance measure for companies that own income-producing property, the real estate industry created and maintains a supplemental earnings performance measure known as "Funds From Operations" (FFO).
Adoption of fair value accounting for investment property could alleviate, if not eliminate, the related deficiencies associated with GAAP in the US, as well as the need for a supplemental performance measure. In this regard, we supported the direction of the IASC, but believe there are certain issues that must be more fully investigated before we would be a proponent of adopting fair value accounting for investment property in the US. Some issues of concern include credibility related to valuing assets above cost, inclusion of unrealized gains and losses in operating results, costs associated with implementation, and required disclosures to appropriately adopt a true "marked-to-market" fair value accounting approach.
Concluding Remarks
Based on the foregoing comments, we believe that lessors of investment property should be excluded from the scope of an accounting standard in which lessors would be required to report the fair value of leases - especially if standards currently or eventually require the reporting or disclosure of investment property at fair value. If the primary reason for reviewing lease accounting is to ensure that a lessee reflects the rights and obligations arising from a lease in its financial statements, the focus of new standards should be on lessee accounting.
NAREIT appreciates the opportunity to participate in the Board's considerations with respect to accounting for leases. If you should have any questions regarding this response, please contact George Yungmann at (202) 739-9432, David Taube at (202) 739-9442, or me at (484) 530-1888.
Sincerely,
Timothy A. Peterson
Executive Vice President and Chief Financial Officer, Keystone Property Trust
Co-Chair, NAREIT Accounting Committee