Chapter 3 — Real Estate Operations Acquired or to Be Acquired

3.2 Determining Whether Real Estate Is Subject to Rule 3-14

The SEC staff has held that Rule 3-14’s reduced financial statement requirements, which are premised on the continuity and predictability of cash flows ordinarily associated with leasing real property, apply to the acquisition or probable acquisition of real estate operations. Rule 3-14 does not define the term “probable.” However, the concept is the same as that under Rule 3-05. See Section 2.2 for further discussion.

Rule 3-14(a)(2)(i) states, “The term real estate operation means a business . . . that generates substantially all of its revenues through the leasing of real property.” Real property generally includes offices, apartments, and industrial buildings as well as shopping centers and malls.

Conversely, Rule 3-05 applies to operations that are susceptible to variations in costs and revenues over shorter periods as a result of market and managerial factors. Such operations include golf courses, hotels, parking garages, nursing homes, assisted living facilities, automobile dealerships, and equipment rental operations.

In addition, the acquisition of a real estate operation encompasses the acquisition of an interest in such an operation that is accounted for by the registrant under the equity method or the fair value option (see Rule 3-14(a)(2)(ii)).

The ability of a registrant to file only statements of revenues and expenses for acquired or to be acquired real estate operations in accordance with Rule 3-14 is not affected by whether the real estate operation is a business for accounting purposes. For example, an apartment building may not meet the definition of a business under ASC 805 and still be subject to Rule 3-14 if it qualifies as a real estate operation.

If a registrant acquires an equity interest in an existing legal entity (e.g., a partnership, limited liability corporation, or corporation) that engages in activities other than leasing (e.g., property management or development), the requirements of Rule 3-05 generally apply. A registrant should consult with the CF-OCA if it believes that because operations other than leasing real estate are limited, Rule 3-14 financial statements are more appropriate than Rule 3-05 financial statements. If the entity has no operations other than holding real estate and related debt, and the significance of the acquisition is greater than 20 percent, Rule 3-14 applies.

We understand that a registrant is considered to have acquired properties if it has invested in a newly formed partnership or corporation (either consolidated or accounted for by using the equity method) that will acquire leased properties upon its formation or soon afterwards. If leasing real property is the new entity’s only activity, the registrant must provide Rule 3-14 financial statements of the underlying property being acquired instead of Rule 3-05 financial statements of the newly formed entity.

Example 3-1

Registrant A owns several apartment buildings for which it also serves as leasing agent and manager. It acquires Apartment Complex X from Company Y, which owns several apartment complexes. Rentals are the principal source of X’s revenue before the acquisition.

Since X qualifies as a real estate operation, A reports the acquisition in accordance with Rule 3-14.

Assume instead that X was held by a limited partnership that had no operations other than holding X and related debt. If A acquired the limited partnership, the same conclusion would apply.

Example 3-2

Registrant G owns and operates several golf courses. It acquires Golf Course Complex R, which consists of a golf course, hotel, and restaurant. In addition to charging greens fees for the use of the course, R obtains revenues from cart rentals, food and beverage sales, golf equipment sales, and hotel rooms.

Although the acquisition involves real estate and rental revenue (i.e., greens fees and cart rental fees), R’s revenues also include food and beverage sales, sales of golf equipment, and hotel room charges, which are highly susceptible to variations attributable to market and managerial factors. Since the acquisition of R does not qualify as an acquisition of a real estate operation, G reports it in accordance with Rule 3-05.

3.2.1 Special Circumstances

3.2.1.1 Rental History That Is Unavailable, Limited, or Unrepresentative

Under Rule 3-14, a real estate operation must generate “substantially all of its revenues through . . . leasing.” There may be circumstances in which the acquisition of real property does not meet the definition of a real estate operation. For example, this could be the case if a registrant acquires:

Newly constructed property with no previous leasing history.
Owner-occupied property for which a rental history does not exist.

If a registrant concludes that the acquisition of property is not within the scope of Rule 3-14 (and does not provide the abbreviated financial information required by Rule 3-14), it should consider whether it is subject to the Form 8-K filing requirements for acquisitions of assets. Form 8-K, Item 2.01, requires disclosures for acquisitions of significant assets that differ from the financial statements required by Rule 3-14. In accordance with Instruction 4 of Form 8-K, Item 2.01, an asset acquisition is deemed significant if “the registrant’s and its other subsidiaries’ equity in the net book value of such assets or the amount paid or received for the assets upon such acquisition or disposition exceeded 10 percent of the total assets of the registrant and its consolidated subsidiaries.”

Example 3-3

Company A sells an office building that it used as its corporate headquarters to Registrant B, a real estate investment trust (REIT). Registrant B subdivides the building and will lease it to several tenants.

If B concludes that it does not need to present separate abbreviated income statements for the building under Rule 3-14 because it did not have a prior rental history, it should consider the requirements of Form 8-K, Item 2.01.

An acquired or to be acquired property may sometimes have a limited rental history, or the rental history may be unrepresentative of future operations. In such cases, Rule 3-14 applies regardless of the limited rental history or expected changes in future operations. However, there may be circumstances, including the following, in which accommodations are available or in which registrants may wish to seek a Rule 3-13 waiver, which would permit them to omit the financial statements of an acquiree under Rule 3-14:

Limited rental history — A registrant may acquire a new property whose lease history is less than nine months. On the basis of SEC staff guidance, the registrant may (1) omit an abbreviated income statement if the rental history is three months or less or (2) provide an unaudited abbreviated income statement for a period of between three and nine months.
Unrepresentative rental history — A registrant may acquire properties on which it intends to demolish the current structure(s) and redevelop the land. In such cases, the registrant may omit the abbreviated income statement because the information is not material given the intended change in operations. However, the registrant should clearly explain why it is not providing the income statement (e.g., it intends to redevelop the property and thus the leasing history is not representative) in the Form 8-K filed upon the close of the transaction.

In addition to the circumstances described above, there may be other instances in which rental history is unavailable, limited, or unrepresentative. In such cases, registrants may wish to seek a Rule 3-13 waiver to omit the financial statements of an acquiree under Rule 3-14 if the information may not be material given the total mix of information available to investors.

3.2.1.2 Properties Subject to Triple Net Leases

A triple net lease requires the lessee to pay costs associated with ownership of the property, such as property taxes and insurance, utilities, and maintenance expenses. Accordingly, such a lease operates as a financing arrangement for the lessee. For Rule 3-14 purposes, the acquisition of property subject to a triple net lease is treated in the same manner as the acquisition of other property. Abbreviated income statements of the property subject to a triple net lease must be provided if the significance requirements in Rule 3-14 are met. However, a registrant must also assess whether it has to include a tenant’s separate financial statements in connection with the acquisition and on an annual basis after the acquisition if the triple net lease represents a “significant asset concentration” (see Section 2340 of the FRM). This would be the case if, for example, a property that is subject to a triple net lease with a single lessee/tenant represents 20 percent or more of a registrant’s total assets as of the most recent balance sheet date. In such an instance, the registrant must provide audited financial statements of the lessee/tenant for the same periods required for the registrant. A registrant may seek modifications to these requirements through the waiver process.

The requirement to assess the significance of an asset concentration (when a registrant is providing a lessee’s or guarantor’s financial statements) is separate from the requirement to assess significance under Rule 3-14 related to providing financial statements for the property. A registrant must perform both assessments and provide the appropriate financial statements. While modifications are allowed under the significance tests in Rule 3-14 for blind-pool offerings (i.e., the investment test), Section 2340 of the FRM indicates that such modifications are not permitted in the assessment of the significance of an asset concentration. (See Section 3.3.2.1 for further discussion of blind-pool offerings.) Registrants are encouraged to request preclearance with the CF-OCA if they believe that less detailed financial information is appropriate on the basis of their facts and circumstances or if the financial statements of the tenant or lessee are not available. Rule 3-14 does not differentiate between the acquisition of property subject to a triple net lease and the acquisition of any other real estate operation. At the 2020 AICPA & CIMA Conference on Current SEC and PCAOB Developments, the SEC staff clarified that, for acquisitions of real estate operations subject to triple net leases, registrants may no longer provide financial statements of a significant tenant in lieu of Rule 3-14 financial statements of the acquired real estate operation to report the consummation of the acquisition (for Form 8-K reporting purposes). Therefore, for the acquisition, the financial statements provided in accordance with Rule 3-14 are the historical abbreviated income statements for the property acquired (not the lessee/tenant/guarantor financial statements). However, given its ongoing requirement to assess the significance of asset concentrations (as applicable) in the filing of an annual report or registration statement, the registrant may also need to provide the financial statements of the lessee/tenant (not the abbreviated income statement of the property) even if such lessee/tenant financial statements are not required at the consummation of the acquisition (for Form 8-K reporting purposes).

3.2.2 Materiality Under ASC 805 Versus Significance Under Rule 3-14

If a business acquisition does not meet the Rule 3-14 significance thresholds for financial statement presentation, a registrant may still need to provide the financial statement disclosures required by ASC 805 in the period in which the acquisition is consummated. Materiality under ASC 805 is not the same as significance under Rule 3-14. See Section 2.3 for further discussion.

In addition, many real estate acquisitions do not meet the definition of a business under ASC 805 for U.S. GAAP purposes; however, they may qualify as a business under Regulation S-X, in which case they would be required to prepare preacquisition financial statements for SEC reporting purposes.

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This SEC Reporting Interpretations manual provides comprehensive guidance; however, the manual does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.