Impact of Covid-19 on Financial Reporting in Real Estate Industry

The COVID-19 pandemic had a widespread impact on the global economy due to the lower volume of transactions leading to losses. In the real estate sector, the impact has been even more significant since the ticket size of each real estate deal is high.

Lower transactions volumes have meant the non-availability of reliable market data needed for accurate real estate financial reporting. There is no fresh supply of real estate from developers. Landlords and tenants are cautious about new deals. There are more assumptions in reporting.

Deals are either being restructured, kept on hold, or scrapped altogether. We don’t know when volumes will pick up and what reference points to use for real estate asset valuation. Let’s find out the implications of COVID-19 on real estate financial reporting.

Impact of COVID-19 on Real Estate Financial Reporting

Collectability of Lease Payments

The lessor must account for bad or doubtful debt when considering lease payments in real estate financial statements. Lease rent should be classified according to its collectability, including any changes, as per U.S. GAAP or Generally Accepted Accounting Principles.

This collectability analysis should be accurate. Revenue should be recognized only on actual receipt, especially during times of prosperity or distress.

A red flag for possible collectivity issues is the presence of deferred lease payments and additional disclosures in the financial statements.

Rent Concessions

With uncertainty in revenues for tenants, most lessors have granted rent concessions to them. There has either been a deferral, complete waiver, or reduction in monthly lease payments. There was no provision for lease modification due to the pandemic under US GAAP, and the FASB or Financial Accounting Standards Board has acknowledged this.

Lessors and lesser have been given the flexibility to:

Follow the existing lease modification guidelines or
Consider the changes as part of the original lease terms if there are minor changes in the contract. Long-term lease extensions or changes in the lessee’s rights are major changes that would require modification in the lease agreement

Impairment

Real Estate Companies need to conduct robust impairment testing of their assets. A higher level of testing would be required where companies suffer a loss of high-value tenants and lower future cash flows due to rent concessions or challenges with collectability.

The loss due to the difference in net book value and fair value should be reflected in the income statement, and the debtor should be recorded at its fair value in the balance sheet. Estimating fair value is a challenge with a lack of sufficient external data and discounted cash flow techniques.

Actions to Take

Make Use of the Best Information Available to You

To arrive at a fair value of real estate assets, the material uncertainty clause provided by a valuer is not sufficient. For a more accurate picture, internally generated data and broader assumptions are vital. The approach of other market participants regarding valuation for financial reporting is also essential.

Transparent Reporting

The valuation of a business is based on information provided by its key financial statements, the income and expenditure account, and the balance sheet. For this reason, transparency in real estate financial reporting is crucial.

All stakeholders in a business comprising banks, lenders, or investors depend on the financial reports to measure its fair value. Disclosures made in the financial statements should be accurate, and valuation techniques for assets should be clearly stated.

Long-Term View

Valuation of the business should be taken from a long-term perspective, given the current uncertainty. Stakeholders should look at tenant retention rates, liquidity, provision of facility management services like repairs, and how the lending norms of banks are met. These factors should be considered for the valuation of real estate businesses.

Conclusion

It will take time for the economy to stabilize, and further changes in real estate financial reporting standards are anticipated. Real estate companies who don’t comply with the new normal for businesses will come under the scanner. Some of the parameters that a company needs to watch out for include meeting loan covenants, lease restructuring, and valuation for asset acquisition. It is essential to engage a real estate accounting professional to ensure that the new norms are followed.

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