The FASB's proposal would be a significant change for entities that currently follow a historical cost accounting model (e.g., certain REITs), and real estate funds that follow a variety of fair value accounting models.

The Financial Accounting Standards Board (FASB) recently issued an exposure draft that would significantly change the way real estate entities account for their investments.

Fair value

The proposal requires investment property entities to measure investment property at fair value with changes in fair value reported in net income.

Investment property entities would present investment property assets and related debt on a gross basis on the balance sheet, and rental revenue and related expenses on a gross basis in the income statement.

Investment property entities would only consolidate controlling interests in other investment property entities, investment companies and entities that provide services to such entities.

The FASB's proposal would be a significant change for entities that currently follow a historical cost accounting model (e.g., certain REITs), and real estate funds that follow a variety of fair value accounting models.

The proposal would also affect real estate funds that follow the investment company guide and account for their investments at fair value without consolidation.

Investment companies

In addition, the FASB is now also proposing an amendment to the investment company guidance, which funds currently follow.

As the guidance is currently proposed, it appears that many of the funds that invest solely in real estate will fall under the definition of investment property entities instead of investment companies, which would require them to fully consolidate many of their investments based on US GAAP consolidation rules.

Real estate fund managers are going to have to show rental income, real estate taxes, operating expenses, property level debt, etc. on the financial statements—a difference from the way it is presented under the current investment company model.

This proposed change will require a significant amount of effort to obtain and maintain this additional information. Worse yet, if a fund falls under the investment company entity model, as opposed to the investment property entity model, and has a controlling financial interest in an investment property entity, it would be required to consolidate the investment property entity.

This means the fund would not be able to present the net investments on one line; rather, it would show a gross presentation of the assets and liabilities and revenues and expenses of the investment property, which would then result in the presentation being more like an investment property entity.

The investment company may also be required to present noncontrolling interests in its consolidated financial statements.

Real estate fund managers may not have access to the information required to properly prepare consolidated financial statements. Fund managers should consider the proposed changes and share their comments with the FASB prior to the 15 February 2012 deadline.

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