The widespread effects of the COVID-19 disruption on the real estate industry have not been uniform, with the impact varying by sub-sector. With shops closed and discretionary spending moving online, the already beleaguered retail sector has suffered. Meanwhile, the halting of business and leisure travel has negatively affected hotels and others in the hospitality industry.
Organizations urgently need to better understand the immediate and potential long-term accounting and disclosure implications of the COVID-19 real estate market. In a new KPMG paper, COVID-19 and financial reporting challenges of the real estate industry, we tackle this imperative and explain the key accounting issues that companies need to know.
The COVID-19 disruption has decreased rent collections significantly in certain property sectors. To help alleviate the economic pressures facing tenants, some landlords have offered concessions, including one-off rent reductions, rent waivers, and deferrals of lease payments.
The Financial Accounting Standards Board (FASB) offered relief during the second quarter of 2020 by permitting entities to elect to apply or not apply the lease modification guidance for concessions related to the effects of the COVID-19 disruption that do not result in a substantial increase to the rights of the lessor or the obligations of the lessee. Concessions that only grant a rent reduction or waiver, or defer lease payments, would typically qualify, as would such concessions coupled with short-term lease extensions roughly equivalent to a free-rent or deferral period. The accounting that follows will depend on the nature of the concession. For example, free rent or rent forgiveness will typically be accounted for as negative variable rent.
All lessors must monitor changes in collectibility of unpaid lease payments individually for each operating lease. Economic effects of the COVID-19 outbreak may change the assessment of collectibility for some leases. Significant rent deferrals and short-payments may call into question whether the lessee will be able to repay. For example, those with a retail-industry tenant may, either as a result of the economic circumstances or because of deferred or short-paid rent, determine that it has become less than probable that the lessee will pay substantially all of the lease payments due. In such instances, a lessor must adjust the accounting for the affected lease, even if no formal modification has been discussed or approved.
We expect that changes in the business climate, market prices of real estate assets, and anticipated future cash flows may trigger impairment testing. In addition, lessors should consider whether balance sheet items, such as capitalized initial direct costs or tenant improvement incentives, are impaired. Although most entities have in place robust impairment testing processes, COVID-19 introduces an additional layer of complexity and underscores the need for carefully reasoned and documented judgments. The effects of COVID-19 on the real estate market have not been uniform, and indeed vary considerably by sector:
- High impact: retail, hospitality
- Medium impact: office, health care
- Low impact: industrial, storage, data centers
While visible market effects should be assessed for impairment analyses, companies will also need to consider expectations for the future, including the prospects for recovery.
All companies should consider whether the economic effects of the COVID-19-induced uncertainties will affect accounting outcomes. For much more detailed discussion of key issues, as well as what real estate executives need to consider as they prepare for the new reality, please download our full report.