Real Estate Accounting Made Easy Book

Real Estate Accounting Made Easy Book
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    E1INDEX06/16/201011:46:5Page 192

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    E1FFIRS06/16/201016:7:46Page 1REAL ESTATEACCOUNTING MADE EASY

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    E1FFIRS06/16/201016:7:46Page 2

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    E1FFIRS06/16/201016:7:46Page 3REAL ESTATEACCOUNTING MADE EASYObioma Anthony EbisikeJohn Wiley & Sons. Inc.

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    E1FFIRS06/16/201016:7:47Page 4Copyright# 2010 by John Wiley & Sons, Inc. All rights reserved.Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.No part of this publication may be reproduced, stored in a retrieval system, ortransmitted in any form ...

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    E1FFIRS06/16/201016:7:47Page 5This book is dedicated to my parents, Richard and Josephine Ebisike,for giving me a wonderful life. I continue to admire the life they lived.They provided me and my siblings with a home and an atmospherethat inspires love, peace, and confidence. In so many ways they...

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    E1FFIRS06/16/201016:7:47Page 6

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    E1FTOC06/16/201016:37:30Page 7ContentsAbout the AuthorxiPrefacexiiiChapter 1Introduction to Real Estate1Types of Real Estate Assets1Common Industry Terms8Chapter 2Basic Real Estate Accounting17History of Double-Entry Bookkeeping17Types of Accounts18Accounting Methods21Recording of Business Transa...

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    E1FTOC06/16/201016:37:30Page 8Additional Cost Recoveries55Operating Expenses Gross-up56Contingent Rents57Rent Straight-Lining58Modification of an Operating Lease61Sublease of Operating Lease65Chapter 5Accounting for Operating Property Expenses67Operating Costs67Chapter 6Operating Expenses Reconc...

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    E1FTOC06/16/201016:37:30Page 9Financing Costs127Relationship Between a Note and a Mortgage128Accounting for Financing Costs128Chapter 13 Accounting for Real Estate Investments andAcquisition Costs129Methods of Accounting for Real Estate Investments129Purchase Price Allocation of Acquisition Costs...

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    E1FTOC06/16/201016:37:30Page 10

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    E1FABOUT06/16/201011:44:51Page 11About the AuthorObioma Anthony Ebisike has over 10 years’ work experience in accounting,in both the audit and real estate fields. He is currently a senior controller ata New York–based international real estate investment firm as well as anindependent invest...

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    E1FABOUT06/16/201011:44:51Page 12

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    E1FPRE06/16/201011:45:27Page 13PrefaceMy goal in writing this book is twofold: to share with you my knowledge ofthe theories and practices of real estate from an accounting and financialperspective, and to provide a resource for easier understanding of the realestate industry from a financial s...

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    E1FPRE06/16/201011:45:27Page 14auditors, accountants, and management understand the roles and impor-tance of audits. Common items normally requested by the auditors are alsodescribed.I am confident that this book will further your understanding of thereal estate industry. My hope in writing this...

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    E1FPRE06/16/201011:45:27Page 15REAL ESTATEACCOUNTING MADE EASY

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    E1FPRE06/16/201011:45:27Page 16

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    C0106/16/2010Page 11INTRODUCTIONTO REAL ESTATEReal estate is generally defined as land and all things that are permanentlyattached to it. These attachments include improvements made to add to thevalue of the land, such as irrigation systems, fence, roads, or buildings. Whenbuyers purchase real e...

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    C0106/16/2010Page 25. Retail properties6. Hotels7. Mixed use propertiesImproved Nonbuilt LandIn economics and business, land is described as one of the four factors ofproduction. (The other factors include labor, capital, and entrepreneur-ship.) The value of land is derived from the demand for la...

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    C0106/16/2010Page 3structure, each unit is rented out to different individuals or families. Thesesmall multifamily properties can be between two and four separate units. Insome cases the owner occupies one of the units and rents the other units totenants. This type of residential property is also...

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    C0106/16/2010Page 4modern energy concepts, design of the building, age, proximity to trans-portation, and tenant mix.Generally, a Class A building is better in terms of the factors men-tioned above than a Class B building in the same market. Class A buildingstend to be close to major transportati...

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    C0106/16/2010Page 5 Regional shopping centers/malls Superregional shopping centers/malls Specialty centers Lifestyle centers Power centers Off-price outlets and discount centers/malls Strip commercial Highway commercialThe main differences among these types of retail properties are thesize of the...

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    C0106/16/2010Page 6tenants include varietyor super-drugstores andhome improvementcentersRegionalshopping centerStores that sell generalmerchandise, shoppergoods, and conveniencegoods; one or moredepartment stores arethe principal tenants300,000 to1,000,000 sq. ft.of gross leasablearea; 30 acres;c...

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    C0106/16/2010Page 7HotelsThere are numerous types of hotel properties, and they are classified basedon the level of service, amenities, and size of the property. The four mostcommon classifications are:1. Full-service hotels2. Boutique hotels3. Extended-stay hotels4. MotelsFull-Service Hotels F...

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    C0106/16/2010Page 8such as convention facilities, restaurants, or room service or other amenitiesfound at full-service hotels. Boutique hotels usually are less known and usu-ally have smaller advertising budgets than full-service hotels.Extended-Stay Hotels Extended-stay hotels aim to be a home a...

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    C0106/16/2010Page 9Accounts Payable A type of liability arising from the purchase of goodsand services from suppliers or vendors on credit.Accounts Receivable A type of asset arising from the sale of goods andservices to customers on credit.Amortization An accounting term used to describe the per...

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    C0106/16/2010Page 10Capitalization Rate (Cap Rate) Therateatwhich future cash flows areconverted to a present value amount. This amount is usually expressedin percent. This rate is sometimes used in the valuation of real estate. Acap rate is commonly calculated using the formula:Cap Rate¼ Annua...

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    C0106/16/2010Page 11Deed A written instrument that evidences the transfer of title from oneparty to another. The party transferring the title is called a grantor; theparty receiving title is called the grantee.Default A party’s failure to fulfill its obligation under any agreement.Examples inc...

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    C0106/16/2010Page 12neighborhood. Examples include the conversion of rental apartments tocondominiums, conversion of hotels to condominiums or to cooperativeproperties, or vice versa.Gross Building Area (GBA) The total area of all floors measured from theexterior of the building and including th...

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    C0106/16/2010Page 13liabilities are liabilities with due dates longer than one year or one operat-ing cycle. Liabilities are listed on the balance sheet according to the duedates, with those due within the year or operating cycles listed first before,for example, those due in 10 years.Loan Commi...

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    C0106/16/2010Page 14Retainage In a construction project, represents a portion of the amountdue under a construction contract that has not been paid by the owner tothe contractor pending completion of the project in accordance withplans and specifications.Retained Earnings The accumulation of net...

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    C0106/16/2010Page 15of each party necessary to enable the creditor(s) to get full or partialrefund of their loan to the debtor.Zoning Restrictions by the government on land use. With zoning, the gov-ernment regulates the type of buildings that can be developed in certainareas. Example: Some areas...

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    C0106/16/2010Page 16

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    C0206/16/2010Page 172BASIC REAL ESTATEACCOUNTINGThe term ‘‘accounting’’ refers to the process of identifying, measuring, re-cording, classifying, summarizing, and communicating financial transac-tions and events to enable users to make informed decisions. Users ofaccounting information i...

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    C0206/16/2010Page 18TYPES OF ACCOUNTSAn account is a location within an accounting system in which the debit andcredit entries are recorded. Organizations use numerous types of accountsin recording transactions. These accounts are grouped into eight categories.1. Assets2. Liabilities3. Owner’s ...

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    C0206/16/2010Page 19Liabilities AccountsThe FASB defines ‘‘liabilities’’ as probable future sacrifices of economic ben-efits arising from present obligations of a particular entity to transfer assetsor provide services to other entities in the future as a result of past transac-tions o...

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    C0206/16/2010Page 20Revenue AccountsAn entity’s revenue represents inflow of assets received in exchange forgoods or services provided to customers as part of the major or central op-erations of the business.2Common revenue accounts in a real estate operation include: Base rents Operating expe...

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    C0206/16/2010Page 21market value of investments above their purchase prices. Examples ofgains include: Realized and unrealized gains on marketable securities Gains on sale of equipment Gains on sale of land Gains on sale of buildingsLoss AccountsLosses represent amounts at which amounts received ...

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    C0206/16/2010Page 22Cash BasisCash basis accounting is a method of bookkeeping in which revenues arerecognized when the related cash is received and expenses are recordedwhen cash is paid. This method is commonly used in small businesses wheretransactions are less complicated and where revenues a...

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    C0206/16/2010Page 23Reserve for Doubtful Receivables Under GAAP, receivables deemedto be uncollectible are reserved and recorded with a debt to bad debtexpense and a credit entry to a contra accounts receivable account. If thereceivable is subsequently collected, the entry would then be reversed....

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    C0206/16/2010Page 24JOURNAL ENTRIESAfter the source documents are received and the proper approvals for thetransactions are obtained, the journal entries should be recorded. Obtain-ing approval for the transaction is very important because it ensures thevalidity of the transaction. For example, c...

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    C0206/16/2010Page 25Journal entries similar to these should be recorded for all expensesincurred during an accounting period.Depreciation Expenses Assets acquired by an entity with more than oneyear of useful life are required to be capitalized and depreciated over theiruseful lives. Examples of ...

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    C0206/16/2010Page 26Therefore, on January 31, 2009, the prepaid insurance account wouldhave a balance of $110,000, which is determined as:Original Prepaid Insurance on12/20/08$120,000January 2009 Insurance Expense10,000Prepaid Insurance Balance on1/30/09$110,000BASIC ACCOUNTING REPORTSA collectio...

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    C0206/16/2010Page 27 Losses Extraordinary items Net IncomeExhibit 2.1 shows the income statement of Boston Properties for theyear ended December 31, 2007.Balance SheetA balance sheet is a financial statement that shows an entity’s financial posi-tion at a point in time, such as at the end of ...

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    C0206/16/2010Page 28Exhibit2.1BostonProperties,Inc.ConsolidatedStatementsofOperationFortheYearEndedDecember31,200720062005(Inthousands,exceptforpershareamounts)RevenueRental:Baserent$1,084,308$1,092,545$1,098,444Recoveriesfromtenants184,929178,491170,232Parkingandother64,98257,08055,252Totalrenta...

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    C0206/16/2010Page 29IncomebeforeminorityinterestinOperatingPartnership,gainsonsalesofrealestateandotherassets,discontinuedoperations,andcumulativeeffectofachangeinaccountingprinciple373,812321,136299,146MinorityinterestinOperatingPartnership(64,916)(69,999)(71,498)Incomebeforegainsonsalesofreales...

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    C0206/16/2010Page 30Current Liabilities Current liabilities consist of: Accounts payable Salaries payable Taxes payable Short-term debts Unearned revenuesLong-term Liabilities Long-term liabilities consist of: Loans Other long-term liabilitiesEquity Section The equity section consists of: Common ...

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    C0206/16/2010Page 31Statement of Changes in Shareholders’ EquityIn a sole proprietorship, the statement of changes in shareholders’ equity iscalled statement of changes in owners’ equity.This statement presents a summary of all transactions that affectedequity during an accounting period. A...

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    C0206/16/2010Page 32the ending equity balance. Examples of transactions that can affect share-holders’ equity include: Net income or loss during the period Issuance of new shares Buyback of outstanding share (treasury stock) Declaration of dividends Other comprehensive income and lossesSee Exhi...

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    C0206/16/2010Page 33Exhibit2.3BostonProperties,Inc.StatementofStockholders’Equity(inthousands)CommonStockSharesAmountAdditionalPaid-in CapitalEarningsinExcessofDividendsTreasuryStock, atCostUnearnedCompensationAccumulatedOtherComprehensiveLossTotalStockholders’Equity,December31,2004110,320$1,...

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    C0206/16/2010Page 34method, the net operating cash balance is determined by tracking all indi-vidual cash receipts and cash disbursements during the period. However,under the indirect method, the net income is adjusted noncash items, suchas depreciation and amortization expenses and other noncash...

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    C0206/16/2010Page 35Exhibit2.4BostonProperties,Inc.ConsolidatedStatementsofCashFlowsFortheYearEndedDecember31,200720062005(inthousands)Cashflowsfromoperatingactivities:Netincomeavailabletocommonshareholders$1,324,690$873,635$438,292Adjustmentstoreconcilenetincomeavailabletocommonshareholderstone...

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    C0206/16/2010Page 36Otherliabilities5,318(9,735)9,305Tenantleasingcosts(34,767)(48,654)(37,074)Totaladjustments(695,312)(345,656)33,957Netcashprovidedbyoperatingactivities629,378527,979472,249Cashflowsfrominvestingactivities:Acquisitions/additionstorealestate(1,132,594)(642,024)(394,757)Investme...

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    C0306/16/2010Page 373FORMS OF REAL ESTATEORGANIZATIONSReal estate ventures are organized in numerous forms. This chapterexplores these forms and presents an in-depth analysis of the characteristicsof each form.The form of ownership of a real estate venture is very important be-cause it has a dire...

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    C0306/16/2010Page 38SOLE OWNERSHIPSole ownership occurs when ownership is in the name of one individual.This is one of the most common forms of ownership of primary residen-ces and small multifamily residential real estate properties. An invest-ment property can also be held through sole ownershi...

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    C0306/16/2010Page 392. In a joint ownership, there is the right of survivorship. This means thatif one of the owners dies, the surviving owner becomes the sole owner ofall the interest in the real estate business. In a common ownership thereis no right of survivorship, thus, if one of the owners ...

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    C0306/16/2010Page 40Legal Characteristics of a Partnership1. A partnership must have two or more persons who are co-owners.2. The purpose of the association should be for a business engaged for profit.3. There should be an agreement between the partners; it can beexpressed or implied.Types of Pa...

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    C0306/16/2010Page 41Limited Partnership A limited partnership is defined as a partnershipwith one or more general partners and one or more additional partnerswhose liabilities are limited to their contribution to the partnership. Thepartners with limited liabilities are called limited partners; ...

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    C0306/16/2010Page 42units called shares, and the owners are called shareholders. Shareholders ofa corporation have limited liability up to amounts invested in thecorporation.A corporation can be publicly or privately (closed) held. A public cor-poration is a corporation whose shares are traded th...

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    C0306/16/2010Page 43Characteristics of a CorporationC and S corporations have these seven characteristics:1. They are separate legal entities from the shareholders.2. C corporations are subject to income taxes at the corporate level while Scorporations are not. However, dividends to shareholders ...

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    C0306/16/2010Page 443. There is no limit on the number of members.4. Unlike an S corporation, there is no limitation on the kind of investors.5. The LLC can issue different classes of shares.6. LLCs can be structured to be classified as partnerships for federal in-come tax purposes.REAL ESTATE I...

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    C0306/16/2010Page 45than 5 investors can own more than 50 percent of the entity. Through thisact, Congress tried to ensure that the benefits of REITs are made availableto a larger population of ordinary investors in the market.REIT AssetsThe purpose of a REIT is for investment in the real estate...

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    C0306/16/2010Page 46

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    C0406/16/2010Page 474ACCOUNTING FOROPERATING PROPERTYREVENUESIn general, properties derive revenues through multiple channels. Some ofthese include base rent, operating expenses recoveries, real estate taxes re-coveries, bill-back profits, antenna space rental, operation of vendingmachines, amon...

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    C0406/16/2010Page 483. Fixed base lease4. Base-year leaseEach of these lease arrangements determines which party bears the risk offuture operating cost increases and to what extent.Gross LeaseA gross lease is a type of lease arrangement in which the tenant pays a speci-fied amount that covers th...

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    C0406/16/2010Page 49ExampleWestern 465 Tower LLC, the owner of a property located at 465 Tower Lanein Boston, is leasing the whole fifteenth floor of the 25-story property toAshwood & Brown Partners LLC (‘‘tenant’’), a prestigious hedge fund that iscurrently located two blocks from ...

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    C0406/16/2010Page 50Fixed Base LeaseThe fixed base lease is a hybrid of a gross lease and net lease. In a fixed baselease, the tenant pays a gross amount that covers the base rental of thepremises plus operating expenses. However, the total amount that the te-nant pays is broken down into the b...

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    C0406/16/2010Page 51the tenant’s pro rata share of the actual operating expenses is less than theoperating expenses portion of the gross payment, the tenant does not get acredit or refund.Base-Year LeaseThe year in which a lease started is called the base year of a base-year lease.During the ba...

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    C0406/16/2010Page 52REVENUE RECOGNITIONAccording to Securities and Exchange Commission’s Staff Accounting Bul-letin (SAB) 104, in general, revenue should be recognized when it is realizedor realizable and earned; and revenue is deemed realized or realizable andearned when these four criteria ar...

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    C0406/16/2010Page 53This chapter simplifies these accounting pronouncements for ease ofuse.LEASE CLASSIFICATIONLeases are classified from the point of view of the lessee or lessor. There-fore, they should be accounted for differently based on specific criteria andaspects of the lease. These cr...

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    C0406/16/2010Page 54shall be the date that construction of the property is completed or the propertyis acquired by the lessor.Bargain purchase option. A provision allowing the lessee, at his option, topurchase the leased property for a price which is sufficiently lower than theexpected fair valu...

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    C0406/16/2010Page 55purchase of the leased property. When the lessor has the right to re-quire the lessee to purchase the property at termination of the leasefor a certain or determinable amount, that amount shall be considereda lessee guarantee. When the lessee agrees to make up any deficiencyb...

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    C0406/16/2010Page 56 Repairs and maintenance Utilities Heating, ventilation, and air conditioning Management fees Freight servicesExcept for real estate taxes, in most cases these recoveries are paidmonthly to the landlord. Real estate taxes are treated differently becausethe frequency of payment...

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    C0406/16/2010Page 576Multiply by Full Occupancy as Defined by Lease (%)95%7Grossed-up Variable Expense491,3798Plus Fixed Component of Expense (from above)100,0009Total Grossed-up Expense$591,379To determine each tenant’s share of the recovery, the tenant’s pro ratashare would be multiplied b...

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    C0406/16/2010Page 58RENT STRAIGHT-LININGIn practice, the total rental payment to the lessor from the lessee is com-prised mostly of the minimum lease payments, operating expenses and realestate tax recoveries, and contingent rentals. As was described earlier, theminimum lease payments can be agre...

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    C0406/16/2010Page 59tax recoveries, and contingent rents because these amounts cannot be deter-mined at the inception of the lease for the whole lease term. Note that anexception is in gross lease arrangements; in those cases, the minimum leasepayments already include the tenant’s portion of op...

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    C0406/16/2010Page 60(continued )2. ABC Grocery Store is a retail tenant and occupies 60,000 square feet ofspace on the first floor. The lease is for 5 years with one additional 5-yearrenewal option at a discounted rate noted on the breakdown below.This tenant is also on a gross lease, and the g...

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    C0406/16/2010Page 61Lease TerminationSometimes prior to a lease expiration the tenant may decide to terminatethelease or defaultonthe leaseand thereforebeevicted or leavewill-fully. For GAAP reporting entities, due to the straight-lining of thestream of minimum rental payments and scheduled rent ...

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    C0406/16/2010Page 62Exhibit4.1SampleRentStraight-liningScheduleSuite#TenantBeneficial OccupancyDateExpirationDateNetRentable AreaRateRentStepDateRent StepPeriod LengthYearAnnual RentPaymentStraight-lineAmountDeferredRentCumulative DeferredRent101RoxyClothing7/1/20096/30/201440,000$—7/1/2009$...

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    C0406/16/2010Page 63201Watkins&WatkinsLLP1/1/200912/31/2011100,0003.0$15,000,000$15,000,000$—$—301ABC&Associates7/1/200812/31/2008100,000$—7/1/2008$—0.52008$—$2,090,000$2,090,000$2,090,000$112.501/1/2009$112.501.02009$4,500,000$4,180,000$(320,000)$1,770,000$112.501/1/2010$112.50...

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    C0406/16/2010Page 64term, and the criteria in paragraphs 7 and 8 shall be applied for purposes ofclassifying the new lease. Likewise, except when a guarantee or penalty is ren-dered inoperative as described in paragraphs 12 and 17(e), any action thatextends the lease beyond the expiration of the ...

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    C0406/16/2010Page 65SUBLEASE OF OPERATING LEASEA sublease is an arrangement in which the lessee releases leased premises toanother party, generally called a sublessee. In this arrangement, the origi-nal lessee of the lease becomes the sublessor.There are three main types of a sublease:1. Thelesse...

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    C0406/16/2010Page 66theoriginallessorand original lesseevariesdependingon thetypeofsublease.Accounting by the Original Lessor1. If the lessee sublets the premises to a new lessee without any change tothe original lease, then the lessor would not need to change the account-ing of the original leas...

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    C0506/16/2010Page 675ACCOUNTING FOROPERATING PROPERTYEXPENSESNumerous costs are incurred in the operation of a property. Some of thesecosts can be recovered from tenants, depending on the lease. Thus, costs aresometimes distinguished as recoverable and nonrecoverable costs. Properrecording of the...

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    C0506/16/2010Page 689. Repairs and maintenance10. Leasing costs11. Loan closing costs12. Management fees13. Sales and use taxes14. Additional services bill-backsProperty TaxesGenerally property taxes are billed by the city or municipality where theproperty is located. Property tax is a major sour...

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    C0506/16/2010Page 69CleaningCleaning involves the cost of cleaning both inside and outside of the prop-erty. This service is either provided by the property owner’s personnel oroutsourced to third-party cleaning companies. If it is performed by the own-er’s personnel, this cost would be part ...

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    C0506/16/2010Page 70However, in an outsourced cleaning scenario, the parties mightagree that the owner would pay in advance every six months. In this case,the amount paid in advance would be a prepaid asset and amortized overthe beneficial period. Assume the landlord paid $120,000 for cleaningse...

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    C0506/16/2010Page 71The entries to record these types of charges are:Water expense$xxAcquired expense$xxElectricity expense$xxAcquired expense$xxHVAC expense$xxAcquired expense$xxPayrollPayroll includes the compensation cost of all the personnel who performwork for the property. It also includes ...

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    C0506/16/2010Page 72Repairs and MaintenanceRepairs and Maintenance are costs spent to keep the property for its in-tended use. Examples include repair of broken windows and doors, repairof toilets stoppage, replacement of light bulbs, maintenance of the heatingsystem and air conditioner, maintena...

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    C0506/16/2010Page 73Then at January 1, 2011, when the remainder of the broker’s commis-sion is paid, the entry would be:Accrued broker’s commission$300,000Cash$300,000Legal fees are the fees paid to an attorney for drafting the tenant leaseagreement. In most leases the legal fees are paid upo...

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    C0506/16/2010Page 74Loan Closing CostsIn practice, the purchase of real estate in most developed economies ismostly financed with debt. Debt financing involves costs such as applicationfees, origination fees, administrationfees, andsyndication costs, amongothers. These costs are called loan clo...

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    C0506/16/2010Page 75arise because sometimes, during the purchase, the purchaser has not de-cided whether the goods would be consumed by the purchaser or used inthe production of a final product. If the purchaser ends up using or consum-ing the goods, the purchaser has to pay use tax to the state...

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    C0506/16/2010Page 76

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    C0606/16/2010Page 776OPERATING EXPENSESRECONCILIATION ANDRECOVERIESAs discussed in Chapter 4, certain tenant leases may require that the tenantpay a minimum base rent in addition to its prorated share of operatingexpenses. This chapter discusses the typesof expensesthatcan be recov-ered from tena...

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    C0606/16/2010Page 78MOST COMMON RECOVERABLE OPERATING EXPENSESCommon examples of recoverable operating expenses are: Wages and salaries Cleaning Security Electricity Water Heating, ventilation, and air conditioning (HVAC) Repairs and maintenance Insurance Management fees Property taxesMOST COMMON...

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    C0606/16/2010Page 79 Legal fees Advertising and promotional costs Costs of any judgments, settlements, or arbitrations Professional dues of employeesThese nonrecoverable costs are deemed landlord’s expenses andtherefore not the responsibility of the tenants. The list is not all inclusive.Tenant...

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    C0606/16/2010Page 80Actual Operating Expenses RecoveriesWages & salaries$435,000Cleaning$115,000Security$103,000Electricity$120,000Water$75,000HVAC$46,000Repairs$81,000Insurance$130,000Management fees$120,000Property taxes$175,000Total Recoverable Operating Expenses$1,400,000In this example, ...

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    C0606/16/2010Page 81The recovery of capital improvement is treated differently from theother costs. Capital improvements in most cases have beneficial or usefullife of more than one year. So, these types of costs are not recovered fromtenants fully during the year they are incurred; rather, they...

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    C0606/16/2010Page 82

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    C0706/16/2010Page 837LEASE INCENTIVES ANDTENANT IMPROVEMENTSLEASE INCENTIVESLease incentives are payments made by a lessor to or on behalf of a lessee toentice the lessee to sign a lease. Lease incentives may include up-front cashpayments to the lessee, payment of costs on behalf of the lessee (s...

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    C0706/16/2010Page 84the market rental rate from the same lessor without the lease assumption, andthe lessor should estimate any loss based on the total remaining costs reducedby the expected benefits from the sublease or use of the assumed leasedproperty.In addition, any future changes in the es...

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    C0706/16/2010Page 85TENANT IMPROVEMENTSTenant improvements are capital expenditures made by the landlord toprepare the space for lease. Such improvements are capital assets of thelandlord. These improvements are components of the property and there-fore should be capitalized and depreciated over ...

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    C0706/16/2010Page 86The recurring annual journal entry to record depreciation of the im-provement is:Depreciation ($100,000/10)$10,000Accumulated depreciation$10,000If at any time it was determined that the useful life of this improve-ment is different from what was anticipated, the annual deprec...

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    C0706/16/2010Page 871. Whether the tenant is obligated by the terms of the lease agreementto construct or install specifically identified assets (i.e., the leaseholdimprovements) as a condition of the lease.2. Whether the failure by the tenant to make specified improvements is anevent of defau...

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    C0706/16/2010Page 88ready for the new tenant. The question is how the costs of demolition andthe removed improvement should be accounted. Internal Revenue Code168(i)(8)(B) requires that the unrecovered basis of improvements that aredemolished should be written off. If a portion of the improvement...

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    C0806/16/2010Page 898BUDGETING FOROPERATING PROPERTIESWHAT IS A BUDGET?A budget is a formal business plan set by an organization for future businessactivities on which actual future activities would be evaluated. It can also bedescribed as a management tool used to communicate management’s goal...

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    C0806/16/2010Page 902. Presentation of the detail budget, commonly made up of:a. Revenuesi. Office rentsii. Retail rentsiii. Residential rentsiv. Operating expenses recoveryv. Storage rentsvi. Antenna rentsvii. Parking rentsviii. Interest incomeix. Investment incomeb. Recoverable operating expen...

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    C0806/16/2010Page 91d. Capital expendituresi. Capital improvementsii. Leasing commissionsiii. Lease incentivesiv. Tenants improvementsv. Leasing costse. Debt servicingi. Debt serving costsii. Financing costsf. Ownership contributions and distributionsi. Distributionsii. ContributionsDuring the bu...

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    C0806/16/2010Page 92leasing assumptions for expected future leases for the period covered by thebudget. The operating expense recoveries to be included would then be de-termined based on the budgeted operating expenses.Operating ExpensesDetailed knowledge of the building’s operations is require...

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    C0806/16/2010Page 93improvements, payment of lease incentives, and tenant improvements orleasing costs.It is important to note that the categories listed are not all inclusive; arobust budget may require many other categories. In most cases, budgetsare quite extensive—up to tens of pages, depen...

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    C0806/16/2010Page 94

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    C0906/16/2010Page 959VARIANCE ANALYSISIn Chapter 8 we described the budget as a management tool that helps man-agement set the direction of the business and also helps communicate manage-ment’s strategic goal. A variance analysis is the periodic review of actual businessresults and comparison o...

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    C0906/16/2010Page 96Exhibit9.1VarianceAnalysis,SixMonthsEndedJune30,2009YeartoDateActualvs.YeartoDateBudgetYearEndingProjectedvs.YearEndingBudgetedAccountYeartoDateActualYeartoDateBudgetVariance($)Variance(%)Explanation—forvariancesover$25,000and10%YearEndingProjectedYearEndingBudgetedVariance(...

  • Page 115

    C0906/16/2010Page 97Utilities215,238150,000(65,238)À43%Theincreaseisduetohigherelectricityratefromourelectricitysupplier.Thishigherrateisexpectedtocontinueatleastthroughouttheyear.410,000300,000(110,000)À37%Utilitiesareexpectedtobeupabout$110,000in2009duetohigherelectricityratethanwasanticipate...

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    C0906/16/2010Page 98SALIENT POINTS ON A VARIANCE ANALYSISSome of the most salient points to note on the variance analysis in Exhibit9.1 are presented next. A reasonable variance threshold should be established based on boththe actual dollar variance and the percentage variance. This is becausea s...

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    C1006/16/2010Page 9910MARKET RESEARCHAND ANALYSISMARKET RESEARCH DEFINEDIn the field of real estate, market research is the study of the attributes of aspecific geographic area for the primary purpose of making a real estateinvestment decision. Market research is fundamental for a successful re...

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    C1006/16/2010Page 100 When to begin construction on a development project How many units to build this year Which cities and property types to invest in so as to allocate capitalwhere rents are more likely to grow Where to locate new retail outlets and/or which should be closed.1It is important t...

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    C1006/16/2010Page 101Some of the factors usually discussed in the report include: Population and demographic trends Income Education level Transportation Availability of public facilities: amenities, healthcare, recreationalfacilities Crime rate and trends Government regulations and restrictions ...

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    C1006/16/2010Page 102affects the viability of the project. The income growth for an area needs to belooked at also; some areas could be experiencing a negative growth trend dueto residents leaving the area for better locations. Income level also indicatesthe purchasing power of the neighborhood. ...

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    C1006/16/2010Page 103Crime RateNothing kills a neighborhood more than crime. Safety is one of the mostimportant things people consider when determining where to live or work.Numerous surveys have shown the inverse relationship between crime ratesand house prices. Nobody wants to put his or her li...

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    C1006/16/2010Page 104potential tenants have more choices. Information on ongoing projects andon those approved but not begun can be obtained from the department ofbuildings in the area under consideration. Information on conceived proj-ects not yet submitted for approval can be the most difficul...

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    C1006/16/2010Page 105salient factors that investors should expect in a market research report; theycan make a different between success and failure.Exhibit 10.1 is a breakdown of potential sources where some of theinformation noted can be obtained for any geographic area.Exhibit 10.1 Potential So...

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    C1006/16/2010Page 106Frequency:Every five years, years ending in 02 and 07.Source:U.S. Bureau of the Census (www.census.gov/econ).Content:Retail sales by seven-digit NAICS code, number of establishments,and payroll. The report, released each spring, contains estimatesof annual sales, per capita ...

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    C1106/16/2010Page 10711REAL ESTATE VALUATIONAND INVESTMENTANALYSISWHAT IS REAL ESTATE VALUATION?Real estate valuation is the key to investment in the real estate market. Valu-ation answers the question: How much is this property worth today? Inves-tors use different types of analysis and procedur...

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    C1106/16/2010Page 108A very important concept in real estate asset valuation is that investors’expected return has an inverse relationship to the price of the asset. Thisinverse relationship exists because in a real estate valuation model, the fu-ture cash flow of the asset, which is made up o...

  • Page 127

    C1106/16/2010Page 109that capital expenditures, depreciations, and amortizations are not factoredin determining NOI. In general, capital improvements are excluded. Also,depreciation and amortizations are excluded because they are noncashtransactions used in accounting to record the wear and tear ...

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    C1106/16/2010Page 110Exhibit11.1ProjectedNetOperatingIncomeYear1Year2Year3Year4Year5Year6Year7Year8Year9Year10REVENUES:Rentfromexistingleases1,000,0001,050,0001,100,0001,005,0001,100,0001,250,0001,300,0001,380,0001,300,0001,500,000Projectedmarketrentfromleaserenewal———100,000105,000——...

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    C1106/16/2010Page 111Exhibit11.2DiscountedNetOperatingIncomeYears1234567891011REVENUES:Rentfromexistingleases1,000,0001,050,0001,100,0001,005,0001,100,0001,250,0001,300,0001,380,0001,300,0001,500,0001,600,000Projectedmarketrentfromleaserenewal———100,000105,000———110,000——Parkingre...

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    C1106/16/2010Page 112The reversion value usually is determined based on the forecastedNOI of the year after the projected holding period. The reversion valueused in Exhibit 11.2 is determined as:Forecasted yr 11 NOI$910,381ATerminal cap rate6%BReversion value$15,173,017C¼ A=BSelling costs(1,000,...

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    C1106/16/2010Page 113It is very important to make sure that an appropriate cap rate is useddue to its significant impact on the valuation. A half-percent difference canhave a major impact on the value calculated.Sales Comparison ApproachThe sales comparison approach is used predominantly in the ...

  • Page 132

    C1106/16/2010Page 114 Financing terms Market conditions at the time of sale Size Location Physical features Economic characteristics, if the properties produce income Age of the property2These characteristics are then compared between the subject propertyand the comparable properties. In estimati...

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    C1106/16/2010Page 1155. Reconcile the various value indications produced from the analysis ofcomparables into a single value indication or a range of values.3A simplified sample sales comparison valuation for a one-family homewith three similar recent sales in the same geographic area as the sub...

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    C1106/16/2010Page 116Exhibit11.3SimplifiedSalesComparisonAnalysisCharacteristicsSubjectPropertyComparableProperty1ComparableProperty2ComparableProperty3PropertyrightsFeeSimpleFeeSimpleFeeSimpleFeeSimpleConditionsofsaleArm’s-lengthtransactionArm’s-lengthtransactionArm’s-lengthtransactionArm...

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    C1106/16/2010Page 1176. Estimate the amount of depreciation in the structure and, if necessary,allocate it among the three major categories: Physical deterioration Functional obsolescence External obsolescence7. Deduct estimated depreciation from the total cost of the improvements toderive an est...

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    C1106/16/2010Page 118

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    C1206/16/2010Page 11912FINANCING OF REALESTATEInvestment in real estate requires significant capital. Investors therefore of-ten look outside their own firms to the capital market to raise the funds toinvest in these assets. Even investors who have the funds available might notwant to put up th...

  • Page 138

    C1206/16/2010Page 1203. Mortgage banks4. Credit unions5. Pension funds6. Life insurance firms7. Savings and loan associations8. Mortgage real estate investment trustsCommercial BanksCommercial banks usually are chartered by the federal or state governmentsin which the banks operate. Real estate ...

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    C1206/16/2010Page 121the servicing agent on the loan. (Servicing means collecting the periodicmortgage payments from borrowers and remitting them to the lender.)Most mortgage banks are chartered by the state. There are numerous mort-gage banks in every state in the United States.Credit UnionsCred...

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    C1206/16/2010Page 122There are three main types of REITs: mortgage REITs, equity REITs,andhybridREITs.MortgageREITs provide and hold loans and otherbond-like obligations that are secured by real estate collateral. Equity REITsinvest in real estate through the purchase of equity interests. Hybrid ...

  • Page 141

    C1206/16/2010Page 123pre-specified rules and the rules determine the order of principal allocationand the coupon level.’’1TYPES OF LOANSIn general, there are two main broad types of loan: conventional and guar-anteed loans.Conventional LoansIn conventional loans, the risk of the lender not b...

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    C1206/16/2010Page 124In a debt financing, the borrower and the lender normally formalizetheir rights and obligations through an executed loan agreement. A typicalloan agreement would normally contain the following terms: Loan amount Interest rate Down payment Loan service payment Loan maturity d...

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    C1206/16/2010Page 125the transaction. The down payment ensures that the borrower has a finan-cial interest in the transaction and therefore could not easily walk away fromthe deal. In case of default, it also increases the likelihood that the lenderwould be able to recover its money since the le...

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    C1206/16/2010Page 126RecourseRecourse is a loan provision that holds the investor personally liable in theevent of loan default. This means that the lender has the right to go afterthe borrower’s personal assets in event of a default.NonrecourseNonrecourse is the opposite of recourse. In case o...

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    C1206/16/2010Page 127FINANCING COSTSReal estate transactions involve significant costs to obtain the financing andprepare the loan documents. Most of these costs are paid by the borrower.In a few cases, though, they are paid by the lender; however, they are some-how recovered from the borrower....

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    C1206/16/2010Page 128Transfer TaxesTransfer taxes are paid to the municipal government where the property islocated. The amount is determined by the municipal government in thearea. The actual transfer tax paid is based on the loan amount.Legal FeesLoan documents are usually drafted by the lender...

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    C1306/16/2010Page 12913ACCOUNTING FOR REALESTATE INVESTMENTS ANDACQUISITION COSTSAs discussed in Chapter 3, there are different forms of real estate entities inpractice, including general partnerships, limited partnerships, corporatejoint ventures, undivided interests, and public and private real...

  • Page 148

    C1306/16/2010Page 130retained earnings of the investee since the investment by the investor. Un-der this method, only the dividend distributed by the investee company isrecognized by the investor as income on the investor’s books. If at any pointthe investee distributes to investors more than t...

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    C1306/16/2010Page 131of the investment. Thus, the equity method is an appropriate means of rec-ognizing increases or decreases measured by generally accepted accountingprinciples in the economic resources underlying the investments. Further-more, the equity method of accounting more closely meets...

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    C1306/16/2010Page 132Generally, ‘‘control of an entity’’ is defined by one of these points: Ownership of majority of the outstanding voting shares. ‘‘Majority’’here means ownership of over 50 percent. Ownership of majority (over 50 percent) of the financial interests inprofits ...

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    C1306/16/2010Page 133partners is not overcome by the rights of the limited partners and no singlegeneral partner controls the limited partnership, the general partners shouldapply the equity method of accounting to their interests. If the presumption ofcontrol is not overcome by the rights of the...

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    C1306/16/2010Page 134Proponents of this method believe that it is more representative of the in-vestment’s true value compared to the other methods.The clearest example of reporting of fair market value is the reportingof publicly traded shares. In those markets, investors can easily determinet...

  • Page 153

    C1306/16/2010Page 135PURCHASE PRICE ALLOCATION OF ACQUISITION COSTSOF AN OPERATING PROPERTYWhen an investor purchases a building, the purchase price of the transac-tion is presumed as an exchange for certain specific assets that are conveyedfrom the seller to the buyer. Accounting for acquisitio...

  • Page 154

    C1306/16/2010Page 136leased to rent-paying tenants and the other is vacant. The building occu-pied by tenants will command significantly higher value compared to thevacant building for at least two main reasons: (1) It has current cash inflowand (2) no money is going to be spent to lease the bu...

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    C1306/16/2010Page 137ExampleA 200,000-square-foot building was acquired for $2,000,000. The values de-termined for each of the components acquired were:ComponentsValuesLand$ 600,000Building as if vacant$1,200,000Tenant relationships$ 150,000In-place leases$ 250,000Above-market leases$ 100,000Belo...

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    C1306/16/2010Page 138Monthly or quarterly amortization journal entries would be:Depreciation ExpensexxAccumulated Depreciationxx(To record depreciation of building & improvementsover its useful life)Amortization ExpensexxIn-place lease—initial valuexx(To record the amortization of the in-pl...

  • Page 157

    C1406/16/2010Page 13914ACCOUNTING FORPROJECT DEVELOPMENTCOSTS ON GAAP BASISSTAGES OF REAL ESTATE DEVELOPMENT PROJECTThere are three main stages of a development project, and accounting atthese stages can be different. The three main stages are:1. Predevelopment stage2. Development stage3. Postdev...

  • Page 158

    C1406/16/2010Page 140project. Some costs are expensed as period costs, some are capitalized whenincurred as costs of the project, while others are recorded as prepaidexpenses andexpensedinthe period in whichthe relatedrevenuesarerecognized.Predevelopment StageThe predevelopment stage can be descr...

  • Page 159

    C1406/16/2010Page 141It is important to pay particular attention to these costs to ensure thatthey are recorded correctly, as some are required to be expensed whileothers are required to be capitalized. GAAP requires that all costs associatedwith a project that are incurred prior to the acquisiti...

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    C1406/16/2010Page 142Therefore, at any time when it becomes probable that the property wouldnot be acquired, the prior capitalized costs would have to be expensed.Other predevelopment costs that meet the criteria for capitalizationinclude costs incurred to change the zoning of the site and costs ...

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    C1406/16/2010Page 143Exhibit14.1ConstructionCostSummaryCostComponentsProject CurrentCostDraw1Draw2Draw3Draw4Draw5Draw6TotalActualCosttoCompleteSiteCostsSiteCosts3,200,0003,200,000—————3,200,000—SubtotalSiteCosts3,200,0003,200,000—————3,200,000—Architectural/EngineeringDesi...

  • Page 162

    C1406/16/2010Page 144FinancingLoaninterests2,000,00050,00050,00050,00050,00050,00050,000300,0001,700,000FinancingCost300,000—300,000————300,000—SubtotalFinancingCost2,300,00050,000350,00050,00050,00050,00050,000600,0001,700,000LeasingRetailCommissions65,000———————65,000R...

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    C1406/16/2010Page 145capitalized as a cost of that project.’’3 The implication here is that for a costto be capitalized as a project cost, there has to be a clear indication that it isdirectly related to a project. Many costs incurred at this stage are mostlycapitalized, such as site acquisit...

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    C1406/16/2010Page 146Note, however, that in most cases the borrower would not take the cashup front at closing but will draw on the amount periodically (usually once amonth) as bills are received from contractors and vendors through a processcalled the submission of draw.On the amortization of th...

  • Page 165

    C1406/16/2010Page 147costs incurred for real estate taxes from the inception of the project throughthe time at which the property is ready for its intended use should be capi-talized as project costs. Real estate taxes after this period should beexpensed. (See the detailed discussion in the ‘...

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    C1406/16/2010Page 148

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    C1506/16/2010Page 14915DEVELOPMENT PROJECTREVENUE RECOGNITIONSThe process and methodology of revenue recognition depend on the typeof project. The revenue recognition for sale of condominium units is verydifferent from that for the sale of an office building or apartment buildingafter they are b...

  • Page 168

    C1506/16/2010Page 1503. Installment method4. Reduced-profit method5. Percentage-of-completion method6. Cost recovery methodFULL ACCRUAL METHODThe full accrual method is one of the methods of real estate profit re-cognition in which the full sale price and profits are recognized when thereal es...

  • Page 169

    C1506/16/2010Page 151If the two criteria are not met, the seller has to determine which othermethods would be appropriate. However, in addition to the two main condi-tions noted above, a transaction has to meet these four additional criteria:1. A final sale between the buyer and the seller has b...

  • Page 170

    C1506/16/2010Page 152GAAP also requires that for recently obtained permanent loan or firmpermanent loan commitment for maximum financing of the property, theminimum initial investment by the buyer should be whichever of the follow-ing is greater:a. The minimum percentage of the sales value . . ...

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    C1506/16/2010Page 153b. The lesser of:1. The amount of the sales value of the property in excess of 115 percentof the amount of a newly placed permanent loan or firm permanentloan commitment from a primary lender that is an independent estab-lished lending institution.2. Twenty-five percent of ...

  • Page 172

    C1506/16/2010Page 154The buyer’s continuing investment in a real estate transaction shall not qualifyunless the buyer is contractually required to pay each year on its total debt forthe purchase price of the property an amount at least equal to the level annualpayment that would be needed to pa...

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    C1506/16/2010Page 155 A real estate transaction where the seller guarantees a return on theinvestment for a limited period of time. The agreed-upon costs andexpenses incurred prior to the operation of the property should beaccounted for using the deposit method. However, if the guarantee isfor an...

  • Page 174

    C1506/16/2010Page 156Assume that the total cost of the unit sold to the plastics company was$1 million. This amount, which was recorded when incurred as WIP, will berecognized in the income statement as cost of sales with this entry:Cost of sales$1,000,000Work in progress$1,000,000This entry shou...

  • Page 175

    C1506/16/2010Page 157REDUCED-PROFIT METHODIn the discussion on the installment method, we mentioned situations where atransaction meets all the criteria for full profit accrual except that the initialinvestment criteria were not met. The reduced-profit method is similar to theinstallment method...

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    C1506/16/2010Page 158continuing investment criteria were not met. However, for profit to be re-corded using this method, the annual payments by the buyer should at leastequal:1. The interest and principal amortization on the maximum first mort-gage debt that could be used to finance the proper...

  • Page 177

    C1506/16/2010Page 159PERCENTAGE-OF-COMPLETION METHODThe percentage-of-completion method is a revenue recognition methodol-ogy in which revenues and profits are recognized as construction progressesif certain specific criteria are met. This method is used mostly in condomin-ium and time-sharing ...

  • Page 178

    C1506/16/2010Page 160similar aspects of the project. These criteria are some of the basic re-quirements before a percentage-of-completion method can be used inaccounting for a condominium or time-sharing project.2. GAAP requires that the ‘‘buyer is committed to the extent of being un-able to ...

  • Page 179

    C1506/16/2010Page 161Because the determination of the periodic profits to be recognizedis based on the estimated aggregate sales proceeds and estimated totalcost of the project, it is crucial that these two numbers can be reasonablyestimated. If these numbers cannot be estimated, the percentage-...

  • Page 180

    C1506/16/2010Page 162Exhibit 15.2 presents the budget prepared for this development proj-ect. Note that the budget categories can be further detailed for better analy-sis of the costs.2242,800$ 3,080,000$ 5,600,0002321,600$ 1,760,000$ 3,200,0002432,300$ 2,530,000$ 4,600,0002532,300$ 2,530,000$ 4,...

  • Page 181

    C1506/16/2010Page 163Toilet Accessories35,52659,211355,263450,000Window Washing Equip.—33,553221,447255,000Appliances197,368328,9471,973,6842,500,000Kitchen Cabinets——2,600,0002,600,000Window Treatments——200,000200,000Pools——1,850,0001,850,000Elevators——2,650,0002,650,000Plumbin...

  • Page 182

    C1506/16/2010Page 164In addition, care must be taken to ensure that costs are appropriatelyclassified between capitalized and expensed costs. Expensed costs are pe-riod costs that are recognized on the income statement. Capitalized costsbecome cost of sales when the related revenues are recogniz...

  • Page 183

    C1506/16/2010Page 165Assume that after one full year, the project management team still be-lieves the original budget is a reasonable estimate of the total cost of theproject. Also assume that 20 out of the 30 condominium units have beensold. Therefore, based on the actual costs at this time, the...

  • Page 184

    C1506/16/2010Page 166Total units sold at year-end$ 79,200,000Percentage complete32%Revenue to be recognized$ 25,344,000The revenue recognized of $25,344,000 is determined by multiplyingthe percentage complete by the total dollar value of the units under contract(sold).Note that as capitalized cos...

  • Page 185

    C1506/16/2010Page 167In most condominium projects, the developer collects deposits from thebuyer when the contracts are signed. These deposits are recorded as liabilitiesin the developer’s books. Assume that the total deposits on the 20 unitsalready sold equal $20 million. The journal entry tha...

  • Page 186

    C1506/16/2010Page 168Skylights——350,000350,000Curtainwall——4,500,0004,500,000Drywall276,316460,5262,763,1583,500,000Tile/Stone161,842269,7371,618,4212,050,000Wood Flooring—10,0001,490,0001,500,000Carpet——750,000750,000Painting94,737157,895947,3681,200,000Fire Extinguishers5,9219,868...

  • Page 187

    C1506/16/2010Page 169At the end of this quarter, the percentage complete and revenue to berecognized would be determined as:Prior-Period Condo Actual Cost$ 21,355,263Additional Condo Costs during the Quarter$ 1,650,000Total Condo Costs Incurred$ 23,005,263Percentage Complete34%The percentage comp...

  • Page 188

    C1506/16/2010Page 170COST RECOVERY METHODThe cost recovery method is another method of profit recognition of realestate sale. This method can be used in either of these situations: Real estate transactions where the initial investment criteria were notmet and the cost of the property cannot be r...

  • Page 189

    C1506/16/2010Page 171The seller’s balance sheet would show:Receivable from Buyer$ 1,000,000Deferred Assets$ (300,000)Total Assets$ 700,000Therefore, future periodic payments made by the buyer will be re-corded as a reduction of the receivables with a portion credited to interestincome.Cost Reco...

  • Page 190

    C1506/16/2010Page 172

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    C1606/16/2010Page 17316AUDITSAs this book has shown, there are numerous participants in the real estateindustry, and the stakes are almost always very high. Real estate requiresrelatively huge capital, and most times that capital comes from numeroussources. For capital to flow throughout the ind...

  • Page 192

    C1606/16/2010Page 174 Rights and obligations Valuation or allocation Presentation and disclosureIt is important to fully understand the meaning of these managementassertions. In their book,Modern Auditing, Boynton and Kell define theterms in this way:Existence or occurrence:Assertions about exis...

  • Page 193

    C1606/16/2010Page 175The main users of the auditor reports are: Investors Lenders Regulators Suppliers CustomersThese users need audited financial statements and auditors’ reportsfor various reasons. Investors need the material to determine the perform-ance and financial position of the audit...

  • Page 194

    C1606/16/2010Page 176Major Account Balances and Specific Audit ProceduresThis section discusses some account balances and common specific proce-dures performed by auditors.Cash Cash is one of the balance sheet items most susceptible to theft, mis-appropriation, and misrepresentation due to its ...

  • Page 195

    C1606/16/2010Page 177would need to audit the validity of this amount by inspecting the purchaseand sales agreement and the evidence of payment. During subsequentyears, the building improvements should be carried on the balance sheetnet of accumulated depreciation. Auditors would review the compan...

  • Page 196

    C1606/16/2010Page 178reviewed properly, this type of liability may be missed or not recorded dur-ing the correct accounting period.Inquiry Inquiry is a very important audit procedure. It involves discussionswith the client personnel to gain insight into the events and transactionsthat may affect ...

  • Page 197

    C1606/16/2010Page 179For percentage-of-completion revenues recognized on a developmentproject that qualify for this method, auditors would request the revenue cal-culation and would reperform the calculation. Auditors would then makesure the project completion factor used in determining revenue i...

  • Page 198

    C1606/16/2010Page 180Financial Statement Audit Requests During the course of the auditfieldwork, auditors request information to help them form opinions as towhether the financial statements are materially misstated. Auditors com-monly request these items: Draft financial statements Trial bala...

  • Page 199

    C1606/16/2010Page 181activities follow management’s directive. For example, internal audit deter-mines whether: Purchases and cash disbursements are approved by appropriatepersonnel. Journal entries are posted by appropriate personnel. Bank reconciliations are performed periodically as specifi...

  • Page 200

    C1606/16/2010Page 182 Capital projects tracking schedule Approved annual planSales and Use Tax AuditState laws require vendors to charge customers sales taxes on goods and ser-vices purchased within the state. Vendors are therefore required to collectthe taxes and remit them to the state. If a cu...

  • Page 201

    C1606/16/2010Page 183for landlords to make sure that the operating expenses and property taxesbilled to the tenants are correct.Some common documents usually requested by auditors during tenantaudits include: Property tax bills Operating expenses reconciliation Invoices Canceled checks Bank state...

  • Page 202

    C1606/16/2010Page 184

  • Page 203

    E1INDEX06/16/201011:46:4Page 185IndexAccountingaccrual basis, 22cash basis, 22defined, 8, 17federal tax basis, 22reports, 26Accounting Principles Board, 139Accounts payable, 9, 177Accounts receivable, 9, 18, 176Accountsmethods, 21types, 18Additional paid in capital, 19, 30,American Accounting As...

  • Page 204

    E1INDEX06/16/201011:46:4Page 186Capital, 2Capital expenditure, 92, 109.See Capital improvementCapital improvement, 81Capitalization rate, 10, 112Capitalized costs, 164, 166Capital market, 119Cash, 18, 27, 176Cash basis, 22Cash flow(s)Discounted, 108from financing activities,32, 34from investing...

  • Page 205

    E1INDEX06/16/201011:46:4Page 187Gain(s), 20–21Generally accepted accountingprinciples (GAAP), 22–23, 58,139, 152, 160Gentrification, 11Gross building area, 12Gross rentable area, 12Guaranty, 126Hotel(s)full–service, 7boutique, 6–7extended stay, 8HVAC, 4, 70Improvement(s), 1Income approac...

  • Page 206

    E1INDEX06/16/201011:46:4Page 188Loss, 21, 27Luca Pacioli, 17Market analysis, 99Market research, 99–100Market value, 107Mezzanine debt, 122Minimum lease payment, 54Mortgage, 13, 128Mortgage real estate investmenttrusts, 121Motel, 8Multifamily properties, 2Nasdaq, 42, 134Net income, 13, 27Net los...

  • Page 207

    E1INDEX06/16/201011:46:4Page 189Renewal option, 126Rentbase, 20contingent, 57definition, 13straight-lining, 58–59Reserve for doubtful receivables, 23Residential property, 2Retainage, 14Retained Earnings, 14, 19, 30,Revenue, 20, 90, 91, 178Revenue recognition, 22, 24, 52,149, 159Right(s)Ownersh...

  • Page 208

    More complex types of transactions, such as development project revenue recognition, are also discussed in depth. In addition, you’ll learn what to expect from audits that real estate entities are subjected to, with audit processes and procedures broken down to help you—whether you are an aud...