PRINT THIS STORY:

CHANGE TEXT SIZE:

REITS RETHINK LEASE ACCOUNTING METHODS

An increase of late filings and accounting restatements among REITs in March is no sign that internal controls are weak in the industry, sources say. Instead, they say, the problem involves the discrepancy between the way the SEC has interpreted so-called tenant build-out periods and the way REITS have reported them.

A build-out period is the amount of rent-free time that a landlord gives a tenant to prepare or remodel a space before it opens for business.

“We’ve never considered the period during which a retailer was preparing their space as part of the lease term,” said Bernard Freibaum, CFO of General Growth Properties.

In many cases, property owners have considered a retailer’s actual opening day as the first of the lease period, which in effect has given the tenant typically two to three months of rent-free time — or at least the perception of a rent break.

But in February the SEC wrote to a major accountants’ association that companies should record lease payments from the date the retailer agrees to take a space, not from the time it moves in.

Most public retailers had been showing the payments on either the store opening date or the lease commencement date, whichever came first. In accordance with the SEC’s letter, though, many retailers restated their financials for 2004 and 2003, and some went back to 2002. Most, including Limited Brands and Coldwater Creek, said they would begin recording rent expenses from the time they obtain a store space, including the build-out period.

Thus, REITs will need to record something for that time period too, not just leave those months blank, says the SEC. And a commission spokeswoman says the issue may come to the forefront again, because companies have not looked at the accounting rules for some time. The Financial Accounting Standards Board established these rules back in the 1980s.

All of this came at a rather inopportune time, Freibaum says, just as companies were rushing to file their annual results. “It came up at the last second,” he said. “The 10-Ks were due [March 15].”

General Growth, Cousins Properties, The Macerich Co. and others then requested 15 days to review before filing their 2004 reports. Public companies are generally not required to review financial records for more than two or three years, analysts say. But most REITs will not need to restate earnings based on lease accounting issues anyway, because their independent auditors approve of the current accounting methods. Even if REITs do revise, experts say, the impact of the accounting changes on their funds from operations will be negligible.

The effects of a revision will be twofold, says Jonathan Litt, an analyst at Citigroup Smith Barney. REIT straight-line rents, recorded evenly over the lease term, will be somewhat lower because they are spread out over a longer time, he says. But during a renovation period, straight-line rents will be higher, inflating results for that period.

All things considered, sources say, the lease accounting flap was something of a nonevent, even if it did create a temporary crisis for some CFOs and investor relations officers. If anything, they note, this is a reminder for the industry to remain vigilant in assuring that its standards adhere to SEC rules.

In general, analysts say they do not think the March accounting blip will turn out to be the tip of a financial reporting iceberg. REITs have very good financial disclosures practices overall, says Ryan Dobratz, a REIT analyst at Chicago-based Morningstar, and this is especially true on leases, because real estate is their core business.