3.3 Measuring the Significance of Real Estate Operations
3.3.1 Modified Investment Test
To determine the significance of real estate operations, a registrant only needs
to perform the investment test described in Rule 1-02(w)(1)(i) as modified by
Rule
3-14(b)(2)(ii). The asset and income tests are not applicable.
The registrant applies the modified investment test as follows on the basis of
whether it has an AWMV:
- Registrant has AWMV — The registrant’s
investment in the real estate operation is compared with the
registrant’s AWMV:
- Investment in the real estate operation — This amount is determined on the basis of the “consideration transferred,” which is measured in accordance with the applicable accounting standards. The investment should exclude any debt secured by the real properties that is assumed by the registrant. Contingent consideration should be included on the basis of either (1) fair value (if the applicable accounting standards require contingent consideration to be recognized at fair value) or (2) the maximum amount (unless the likelihood of payment is remote) if recognition at fair value is not required under the applicable accounting standards.
- AWMV — This amount is determined on the basis of the average of the last five trading days of the registrant’s most recently completed month-end before the earlier of the date on which the registrant announced the acquisition or agreed to it.
- Registrant does not have AWMV — This may be the case when a registrant is undertaking its IPO or it is not traded. In these instances, the investment test is based on the registrant’s consolidated total assets as of the end of most recently completed fiscal year before acquisition. When performing the investment test, the registrant compares the “consideration transferred,” which includes any assumed debt secured by the real properties, with its consolidated total preacquisition assets. This treatment of debt secured by the property differs from the treatment of acquired debt when a registrant has an AWMV.
A real estate operation is significant when the investment is
greater than 20 percent of the registrant’s AWMV or total assets, as discussed
above. When acquired or to be acquired real estate operations are related to one
another (see Section
3.3.3), a registrant must use the aggregate investment in these
operations when performing the significance test. The registrant should also be
aware of the considerations related to aggregating individually insignificant
acquired or to be acquired real estate operations (see Section 3.4.2.3).
Example 3-4
Case A — Registrant
Has AWMV
Registrant A’s fiscal year-end is
December 31. It announced the acquisition of Real Estate
Operation E on November 5, 20X8, and completed the
acquisition on November 15, 20X8. On the basis of the
average of the last five trading days of October 20X8,
A’s AWMV is $70 million.
On December 31, 20X7, A had total
consolidated assets of $100 million. Its total
investment in E was $30 million, which includes assumed
mortgage debt of $5 million. The investment test
calculation is performed as follows:
Case B — Registrant
Does Not Have AWMV
Assume the same facts as Case A, except
that Registrant A does not have an AWMV (i.e., its
shares are not traded). The investment test calculation
is performed as follows:
3.3.2 Special Circumstances
The sections below discuss additional considerations that may apply in certain
circumstances.
3.3.2.1 “Blind-Pool” Offerings
Certain registrants that conduct continuous offerings over
an extended period do not initially own any real estate assets, and the
specific intended use of the proceeds raised from investors is not initially
identified because such registrants have not yet selected any assets for
their portfolios. Such “blind-pool” offerings are subject to the guidance in
Industry Guide 5 and therefore have
specific reporting and significance measurement requirements. The
distribution period is the period during which the registrant is conducting
a continuous Securities Act registered offering through a registration
statement to which Industry Guide 5 applies.
In accordance with Rule 11-01(b)(4), when a registrant
conducts a blind-pool offering, only the investment test (modified for
blind-pool offerings) applies — not the income test or the asset test. The
guidance on such offerings applies to acquisitions subject to the
requirements of either Rule 3-05 or Rule 3-14. For acquisitions subject to
Rule 3-05 (i.e., acquisitions of a business), the investment, income, and
asset tests apply. For acquisitions subject to Rule 3-14 (i.e., acquisitions
of real estate operations), only the modified investment test applies. Under
the investment test, the registrant’s and its other subsidiaries’
investments in the real estate operation are compared with the registrant’s
total assets and those of its subsidiaries consolidated. For the investment
test as modified for blind-pool offerings, total assets are determined as
follows:
- During the distribution period — Total assets as of the acquisition date, excluding the acquired real estate operation plus the proceeds (net of commissions) in good faith that are expected to be raised over the next 12 months.
- After the distribution period but before the filing of the next Form 10-K — Total assets as of the acquisition date, excluding the acquired real estate operation.
- After the distribution period and filing of the next Form 10-K — Total assets in accordance with the registrant's most recent annual consolidated financial statements included in the Form 10-K (in a manner consistent with the non-blind-pool general Rule 3-14 significance test).
3.3.2.2 Real Estate Operations Acquired Shortly After the Registrant’s Most Recently Completed Fiscal Year
A registrant may acquire a real estate operation shortly
after its year-end but before filing its Form 10-K for that year. If the
registrant does not have an AWMV, the investment test for such an
acquisition will be based on the consolidated total assets of the registrant
included in its prior-year Form 10-K to assess significance when determining
its initial Form 8-K filing requirements. In certain situations, the
registrant may reevaluate significance by using its total assets for the
most recent fiscal year reported in the Form 10-K filed after the initial
Form 8-K filing. See Section 2.3.1.1 for further discussion and an example.
3.3.2.3 Real Estate Operations Acquired Before Completion of the Registrant’s First Fiscal Year
If a registrant other than a newly formed REIT (e.g., a
master limited partnership) has not completed its first fiscal year, the
total assets in the most recent audited balance sheet filed with the SEC
will be used in the significance test. Typically, this will be the audited
balance sheet included in the registrant’s initial registration statement.
A registrant that is a newly formed REIT with no significant
operations may calculate significance by using a denominator that includes
acquired and to be acquired properties. In such situations, registrants
should consider consultation with their auditors and SEC legal counsel.
3.3.2.4 Use of Pro Forma Financial Information in the Significance Test
A registrant may acquire (or it may be probable that it will
acquire) a real estate operation after a previously reported individually
significant acquisition or disposal of real estate operations for which the
registrant had provided pro forma financial information in a Form 8-K, Item
2.01, or registration statement. In this situation, Rule
3-14 permits the registrant to perform the significance test by using the
pro forma financial information that was included in a previous Form 8-K or
registration statement reporting the acquisition or disposition of
significant real estate operations rather than historical preacquisition
financial statements. The pro forma effects of any other transaction should
be excluded. A registrant that elects to use pro forma financial information
to evaluate significance should apply this approach consistently for all
subsequent acquisitions and dispositions until it files its next annual
report on Form 10-K. See Section 2.3.1.2 for further discussion and an example.
3.3.2.5 Real Estate Operations Acquired or to Be Acquired by the Registrant’s Subsidiary
If the subsidiary is not itself a registrant, significance
should be measured by comparing the investment in the acquiree with the
registrant’s preacquisition consolidated total assets or AWMV (if
available). However, if the subsidiary is also a registrant, the parent and
the subsidiary must each measure whether the acquiree is significant. See
Section
2.3.1.3 for further discussion and an example.
3.3.2.6 Plans to Dispose of Certain Acquired or to Be Acquired Assets
If a registrant acquires a group of properties and plans to
dispose of certain of them, the assets to be disposed of should not be
excluded from the significance calculation. That is, the amount of the
investment must include all acquired real estate operations even if the
registrant plans to dispose of one or more of them. See Section 2.3.1.4 for
further discussion.
3.3.2.7 Previously Issued Financial Statements That Are Retrospectively Adjusted
In certain circumstances, a registrant may be required to
file updated financial statements that reflect the retrospective adjustments
for periods before adoption of the change. In some cases, such changes may
affect the significance calculations. See Section 2.3.1.5 for further discussion
and an example.
3.3.3 Measuring the Significance of Related Acquired or to Be Acquired Real Estate Operations
Rule 3-14(a)(3) states that acquired or to
be acquired real estate operations are related to one another if they “are under
common control or management,” the “acquisition of one real estate operation is
conditional on the acquisition of each other real estate operation,” or “[e]ach
acquisition is conditional on a single common event.”
When a registrant performs the significance test upon its
acquisition or probable acquisition of real estate operations that are related
to one another, it must treat the group of related real estate operations as a
single operation. Therefore, the registrant must compare its aggregate
investment in the related real estate operations with either its AWMV or its
total assets. The related real estate operations are significant when the
aggregate investment exceeds 20 percent of the registrant’s preacquisition total
assets.
If the significance of the group of related real estate
operations exceeds 20 percent, the registrant must present statements of
revenues and expenses for all the related real estate operations, even if a
related real estate operation is individually insignificant (i.e., its
significance is less than or equal to 20 percent on an individual basis). In
addition, a registrant may present combined abbreviated income statements if the
real estate operations are under common control or management and they meet the
criteria in ASC 810-10-55-1B for presentation on a combined basis. However, the
SEC staff may require the combined financial statements of acquired related real
estate operations to be presented separately from the combined financial
statements of related real estate operations that are to be acquired.
Example 3-5
Registrant A consummated the acquisitions of Real Estate
Operations B and C on July 31, 20X9. The acquisitions
were announced on July 5, 20X9, and A, B, and C have a
December 31 year-end.
Real Estate Operations B and C are
related because they were under common control since
January 1, 20X2. The table below summarizes A’s
investments in B and C as well as the calculation of the
combined significance of B and C.
The acquisitions of B and C should be treated as a single
acquisition since B and C are related to one another.
Therefore, to perform the significance test, A must
aggregate its investments in B and C. On the basis of
the significance test results, B and C are 30 percent
significant in the aggregate. Registrant A must present
the abbreviated income statements of both B and C even
though C would not have been significant by itself.
Because B and C have been under common control and the
criteria in ASC 810-10-55-1B for presentation on a
combined basis were met, A may present separate or
combined abbreviated income statements for B and C.
If a registrant acquires a group of individually insignificant related real
estate operations, it should apply the guidance discussed above before applying
the guidance on the acquisition of individually insignificant real estate
operations.
3.3.4 Performing the Significance Test and Determining the Financial Statements Required Upon and After a REIT’s IPO
To determine the financial statements required upon its IPO, a
newly formed REIT with no significant operations (referred to herein as a “newly
formed REIT”) performs the significance test on its acquired or to be acquired
real estate operations. To do so, it uses the total cost of the following as the
denominator:
- Properties acquired immediately before an initial registration statement is filed.
- Properties to be acquired upon closing the IPO.
- Properties identified as probable future acquisitions.
That is, a newly formed REIT compares (1) its investment in the acquired or to be
acquired properties with (2) the denominator.
In the initial registration statement, the newly formed REIT
must include abbreviated income statements for acquired or to be acquired
properties whose significance is individually greater than 20 percent
along with pro forma financial information.
Further, if there are acquired or to be acquired properties whose significance
individually is less than or equal to 20 percent but in the aggregate
exceeds 50 percent, the newly formed REIT must provide pro forma financial
information depicting the aggregate effects of all such individually
insignificant real estate operations. However, the newly formed REIT is not
required to provide separate financial statements for any individually
insignificant real estate acquiree.
Example 3-6
Registrant A, a newly formed REIT, is planning to file a
registration statement for its IPO. Immediately after
its formation, A acquired Real Estate Operations B, C,
D, and E. In addition, it is probable that A will
acquire Real Estate Operations F, G, and H immediately
after the IPO.
The table below lists the cost and significance of each
of the real estate operations acquired or to be acquired
(assuming all such acquisitions occur within the same
year).
Registrant A is permitted to compute the significance of
the real estate operations by using a denominator equal
to the cost of all acquired and to be acquired real
estate operations ($14,500). Because C and G are
individually more than 20 percent significant, A will
present their audited abbreviated income statements in
the registration statement along with pro forma
financial information. Real Estate Operations B, D, E,
F, and H are individually insignificant. However, in the
aggregate, their significance is 52 percent (3% + 12% +
7% + 16% + 14%). Therefore, A must provide pro forma
financial information depicting the aggregate effects of
B, D, E, F, and H.
For acquisitions or probable acquisitions after the IPO but before the initial
Form 10-K is filed, the newly formed REIT can use the same denominator discussed
above to calculate significance. However, the denominator should not include
properties whose acquisition was probable at the time of the IPO but that were
not ultimately acquired, unless audited financial statements of the property
were included in the initial registration statement and the acquisition remains
probable. Thus, the denominator should be reduced for any property not acquired
or whose acquisition is no longer probable. The purpose of this restriction is
to prevent registrants from using a denominator for significance that is
artificially large because of probable acquisitions that will not ultimately
occur.