Reality Check for Real Estate Post-COVID
Thanks to COVID-19 vaccines, business is now bouncing back but many challenges will likely linger for real estate. COVID made financial reporting and accounting much more difficult for owners of real estate due to closures, tenants who stopped paying rent, rule changes for lease accounting, and the office or retail space that went unused.
When preparing their 2020 GAAP year-end financial statements, clients that own real estate property had to deal with issues like asset impairment, going-concern evaluations, tenant receivables, the new lease standard, and accounting for Paycheck Protection Program loans. Where to go from here? Looking forward to 2021 consider the following:
COVID would seem to qualify as a triggering event to asset impairment due to the widespread losses and business closures it triggered, and we are still suffering from. It also precipitated decreased cash flow, reduced occupancy, and created a “deterioration in the environment in which an entity operates,” for some sooner rather than later. For those clients, an impairment assessment would seem important. There is potential for an asset write-down when your tenants are suffering and experiencing losses that leads to a dent in your future net cash flow. When an impairment has been identified, the entity may need to recognize the loss and report it as a current net income item.
Income-producing real estate entities for residential and commercial industrial property should have a conversation with their Fuoco CPA about whether there could be an impairment based on carrying value versus the future net cash flow. Compare cash flow forecasts to contractual rent obligations, and consider the true collectability of postponed rent payments as well as tenants’ readiness to renew their leases. You may also need to consider property valuations as part of an impairment assessment.
Many commercial tenants are asking landlords for rent concessions, or reducing their real estate footprint as they consider whether they can have more of their workforce become remote, or put on a “flex” schedule. There’s probably been a higher frequency of modifications or terminations and lease contract changes, and some clients may not be used to accounting for those. If too many tenants stop paying rent or ask for steep rent concessions, that could affect a landlord’s ability to continue operating as a “going concern.” If an entity is looking at an asset impairment, it could mean they have losses and tenants terminating their leases earlier. Maybe there are liquidity and capital resources issues? All these things impact the indication of a going concern. Private companies do need to satisfy their lender who is looking at the financial statement and may be asking if they going to be able to pay down their loan over the rest of the term. Disclosures may need to be provided to reassure lenders. Some clients may be able to get deferrals on principal and interest payments on their loans, but how does that impact future maturities of long-term debt? When are those deferrals going to come due? Are they going to amortize the debt?
With the strong economic recovery underway this year, more landlords and more tenants are making overdue improvements as they reopen their businesses. Some construction that was started, was halted during COVID so there are construction costs. Tenants continue to be late in paying. Receivables are up, accrued expenses are up, yet clients haven’t actually paid for the capital expenditures. Could be a non-cash item if there are construction costs not yet paid for. If this is your situation, consider the impact on your current year cash flow as well as next year.
Mom and pop shops, local restaurants and other service-based professions will continue to lag. Small shop space vacancies continue downward pressure on rents in commercial real estate. Debts are piling up for many, which may or may not be repaid. See our article on bad debt here: https://www.fuoco.cpa/be-sure-...
PPP Loans and Forgiveness
The Paycheck Protection Program Loans complicated things further this year. You can account for it one of two ways: either the debt method or a grant method. The debt method is similar to how debt would be presented on a normal for-profit company’s balance sheet: you have debt which is recorded as income when it’s actually forgiven. The grant method requires an analysis to say it’s probable that the loan will be forgiven, partially or in full. It’s initially recognized as deferred income and then the gain is recognized in the period over which the related expenses are made. For many clients this would be 2020, so it would not have a balance sheet impact. It would really be all income statement impact.
For many real estate businesses, the PPP is the first time they have participated in a government incentive program and have never had to account for it. For pass-through entities, there are tax considerations as well as the implications of determining when an entity may need some basis or not, which could have an impact on the way that it’s recorded on the financial statement.
Many PPP loans will qualify for full or partial forgiveness. If the loan has not yet been forgiven, real estate professionals and their Fuoco CPA will need to consider the interplay of costs used for forgiveness with employee retention credits prior to filing for forgiveness. See our prior article on maximizing both here: https://www.fuoco.cpa/maximizi...
FASB & Leases
Adding fuel to this financial fire, is the new leases standard, ASC 842, from the Financial Accounting Standards Board. In response to the pandemic, FASB deferred the deadline for adoption by private companies and not-for-profits until fiscal years beginning after December 15, 2021, and interim periods within fiscal years starting after December 15, 2022. Companies still need to get ready to implement the new rules. Finish dealing with the pandemic, but then pay attention to this because it will have a huge impact on the lessees. For those clients who are leasing space where they used to have an operating lease, it will now be on the balance sheet. Have leased equipment? It could have a huge impact there as well.
Reach Out to Us: As a result of the pandemic and its lingering effects, there is still a tremendous amount of uncertainty regarding the commercial real estate market. Many owners of commercial real estate will be contending with the coronavirus pandemic’s impacts on their financial performance for years to come. Interest rates may remain low thru 2021 due to an accommodative Federal Reserve. Keeping short term rates low could provide a favorable backdrop for commercial borrowers. There will be some winners and some losers. As retail, hotel and office prices decline, industrial, data center, life science and single-family homes will continue to increase in value. Let us help you put your company in a more favorable position in the last half of 2021.