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NATIONAL ASSOCIATION OF REAL ESTATE INVESTMENT MANAGERS 34 NAREIM Accounting/Reporting: Illuminating Issues, Before They're an Issue Transparency, consistency, and accuracy are essential when creating, revisiting, or updating a company's operating guidelines. As companies strive to create stronger operating and reporting guidelines, certain trends emerge, for example: INVESTMENT-COMPANY GUIDANCE Many firms use tax-basis accounting or historical-cost accounting under generally accepted accounting principles (GAAP). However, audited financials for companies reporting under investment-company guidance are becoming more standard as investment partners and their investors are pressed to report values that reflect more timely valuations. FAIR VALUE REPORTING When valuation policies exist, they tend to focus on acquisitions and asset management because of the shoot- first-ask-questions-later nature of certain real-estate funds. It's important to establish these policies for all scenarios, however, given the nature of increasing investor requirements, which continue to gravitate toward fair value reporting. DEVELOPMENT-PROPERTY VALUATIONS At minimum, operating guidelines should demonstrate how development properties are valued depending on two measures: • The development stage • How the development stage aligns with the fair value measurement date Both a bottom-up approach—essentially the fair value of the land, development costs, and profit—as well as a top-down approach—the completed, stabilized property with deductions, profit, cost to complete, and leasing—are credible. Both approaches can and should be employed, depending on the complexity of the property or rehab as well as the investment management team's level of sophistication and available resources. In many cases, a third-party appraiser may be a preferable alternative to perform this work. QUARTERLY VALUATIONS Many companies continue to increase internal/external valuation frequency to a quarterly versus annual basis. Most larger companies are also alternating the external appraisal firm they use for annual valuations every three years. Firms aiming for the highest standards in the industry often ascribe to the NCREIF PREA Reporting Standards, which are increasingly used for joint ventures or funds with institutional investors. Example Scenarios of Best-Practice Operating Guidelines The following examples illustrate firms that have used operating guidelines to provide a strong framework for their business processes and financial reporting. RESIDENTIAL REAL ESTATE DEVELOPMENT FIRM WITH PRIVATE-EQUITY PARTNERS A real estate firm specializes in master-planned community and land development, including for-rent and for-sale housing as well as multifamily projects and condo conversions. Although the firm had successfully launched two funds already, it wanted to create a more diversified fund with the potential to attract pension-fund partners for the first time. The effort to create operating guidelines focused on supporting institutional fundraising and establishing timelines driven by financial reporting deadlines for the following reasons: • Engaging third-party appraisers • Reviewing appraisals • Finalizing reports In moving to fair-value reporting, the guidelines—specifically the timeline for engaging appraisers to assist with the more complex assets—proved critical in giving management sufficient time to review the valuations.