Chapter 2 — Identifying the Required Financial Statements for the Registration Statement

2.6 Financial Statements of Real Estate Operations Acquired or to Be Acquired (Rule 3-14)

When a registrant consummates, or it is probable that it will consummate, a significant acquisition of real estate operations, the registrant may be required to file abbreviated income statements for the acquired or to be acquired real estate operations (acquiree) in accordance with Regulation S-X, Rule 3-14. Because the information requirements under Rule 3-14 are different from those under Regulation S-X, Rule 3-05 (discussed above), it is critical to identify whether an actual or planned acquisition is a real estate operation. In contrast to Rule 3-05, Rule 3-14 only requires inclusion of preacquisition financial statements for a significant real estate operation for the most recent year and applicable interim period, regardless of significance. While existing registrants are subject to periodic reporting requirements for significant acquisitions, an entity is not subject to such requirements before an IPO. Therefore, in the context of an initial registration statement, a company must evaluate certain acquisitions of real estate operations.

Rule 3-14 applies to an acquisition of a real estate operation. The definition of a real estate operation is distinct from the determination of a business for SEC reporting purposes. Under Rule 3-14, “the term ‘real estate operations’ means a business that generates substantially all of its revenue through the leasing of real property” such as (1) office, apartment, and industrial buildings and (2) shopping centers and malls. Below are two examples illustrating how an entity may distinguish between a real estate operation that is required to present Rule 3-14 financial statements and one that must present Rule 3-05 financial statements.

Example 2-10

Assume the following:

Registrant A owns several apartment buildings for which it also serves as leasing agent and manager.
Registrant A acquires Apartment Complex X from Company Y, which owns several apartment complexes.

In this example, X qualifies as a real estate operation to A; therefore, A reports the acquisition in accordance with Rule 3-14. Rentals are the principal source of X’s revenue before the acquisition.

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 2-11

Assume the following:

Registrant G owns and operates several golf courses.
Registrant G 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 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. In this example, the acquisition of R does not qualify as an acquisition of a real estate operation. Therefore, G reports the acquisition in accordance with Rule 3-05.

The financial statements and other related information needed for a REIT spin or REIT conversion transaction may vary. (For more information, see Section 3.4.3 of Deloitte’s Roadmap SEC Reporting Considerations for Business Acquisitions.) Registrants are increasingly performing REIT conversions for “nontraditional” real estate operations, such as timber, hotels, casinos, hospitals, golf courses, telecommunication infrastructure, and cold storage facilities.

2.6.1 Periods of Financial Statements Required

There is only one significance test for Regulation S-X, Rule 3-14, the investment test. When performing this test, a company compares the GAAP purchase price with the acquirer’s total assets on the basis of its most recent preacquisition annual financial statements. For a company undertaking an IPO, the investment includes any debt secured by the property that is assumed by the acquirer. Once a company completes its IPO, it will measure significance by using the AWMV of common equity (i.e., market capitalization) instead of total assets. The company will compare the GAAP purchase price (excluding any debt assumed that is secured by the acquired real estate operation) with market capitalization. Companies undertaking an IPO should be aware that the method used to evaluate significance for real estate operations will change upon completion of the IPO.

For acquisitions of real estate operations that exceed 20 percent significance according to the investment test, an entity must include preacquisition abbreviated income statements for one year and the subsequent year-to-date interim period. The acquiree’s financial statements are not required once the registrant’s audited financial statements reflect the operating results of the acquiree for at least nine months. As a result, acquisitions that occurred in the second or third historical period of annual financial statements presented by the registrant will generally not need to be presented in the separate preacquisition financial statements.

Example 2-12

Registrant A acquires real estate operations on March 5, 20X4 (Property B); September 21, 20X4 (Property C); and December 1, 20X4 (Property D). Each acquisition was individually significant at the 20 percent level or higher. All entities have December 31 fiscal year-ends. Registrant A plans to file an initial registration statement on June 1, 20X5.

Since Registrant A’s audited financial statements for the year ended December 31, 20X4, will reflect more than nine months of postacquisition audited results for Property B, no separate preacquisition financial statements for Property B are necessary. For Property C and Property D, given that each property was individually significant at the 20 percent level or higher, A is required to provide Rule 3-14 abbreviated financial statements for:

Property C for the year ended December 31, 20X3 (audited), and the six months ended June 30, 20X4 (unaudited).
Property D for the year ended December 31, 20X3 (audited), and the nine months ended September 30, 20X4 (unaudited).

Generally, the financial statements for a significant acquisition of real estate operations may be audited in accordance with AICPA standards.

2.6.2 Other Considerations

Under Rule 3-14, a registrant is not required to provide the financial statements of individually insignificant real estate properties acquired whose significance does not exceed 20 percent. However, when filing a registration statement, the registrant must evaluate whether the aggregate significance of all probable and consummated acquisitions exceeds 50 percent; this requirement is similar to that under Rule 3-05. In accordance with the investment test, the registrant must aggregate business acquisitions (i.e., under Regulation S-X, Rule 3-05) and real estate operations acquisitions (i.e., under Regulation S-X, Rule 3-14). For more information about individually insignificant acquisitions, see Section 3.4.2.3 of Deloitte’s Roadmap SEC Reporting Considerations for Business Acquisitions.

In addition, the Securities Act and Exchange Act reporting requirements related to “blind pool” offerings subject to SEC Industry Guide 5 are completely different with respect to real estate acquisitions both during and after the distribution period, as discussed in Chapter 3 of Deloitte's Roadmap SEC Reporting Considerations for Business Acquisitions. Blind pool offerings, also referred to as nontraded REITs, are always nonaccelerated filers.

Registrants in the real estate industry will also need to prepare a Schedule III, “Real Estate and Accumulated Depreciation,”and Schedule IV, “Mortgage Loans on Real Estate,” as applicable.

Other important topics for registrants in the real estate industry to consider are triple-net leases, which are discussed in Section 3.2.1.2 of Deloitte's Roadmap SEC Reporting Considerations for Business Acquisitions, and equity method investments, which are discussed in the section below.