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Current developments for the real estate industry
Spring 2017
Table of contents
I. Developments shaping the REIT industry 2
II. In the market and recent real estate trends 5
III. Accounting and financial reporting hot topics 8
IV. Update on tax matters 11
V. Regulatory considerations 13
VI. Governance discussion 15
VII. Technology trends and update 17
I. Developments shaping the REIT industry
PwC | Current developments for the real estate industry 2
I. Developments shaping the REIT industry
6 key takeaways from REITWise
- Byron Carlock, PwC National Partner/Real Estate Practice Leader
My travels have continued in 2017 and I recently had the opportunity to attend NAREIT’s REITWise conference in La Quinta, CA.
The conference covered a variety of beneficial and relevant topics for the REIT industry. Sessions included panels to discuss the state of the real estate and capital markets, impact that the new political landscape is having on the markets, strategic outlook for 2017, and the implementation of new accounting standards such as leases and revenue recognition, among many other relevant topics for law, accounting, and finance professionals across the real estate industry.
Over the course of the few days, I was able to have many engaging conversations with our clients and colleagues regarding current industry developments, the outlook for the REIT industry, and what is on the horizon for the overall real estate market. It was an exciting opportunity to hear from other industry professionals about what they are currently seeing in the market, emerging trends and expectations of what is ahead for the real estate industry as a whole.
During the conference, our US real estate practice hosted a party at the polo fields for industry peers to network and discuss current political, economic and market events that impact various aspects within the REIT industry. With almost 200 industry professionals attending, this was the event of the conference!
Now that I’ve had some time to reflect, here are some of my key takeaways:
The real estate industry is looking generally healthy. Net operating income and funds from operations continue a positive upward trajectory albeit with slower growth as we reach the maturity of the recovery cycle, which has experienced peak recovery in virtually every asset class for the last several years.
All indications point to an elongation of the cycle. Supply and demand statistics are still pointing toward demand exceeding supply, especially in the housing and industrial sectors which appear to continue to be at the top of investor preferences. The new administration in Washington has a continued opportunity to extend this cycle through policies that are friendly to the real estate industry.
Signs of UNDER-valuation of REITs. There are actually some signs of undervaluation of REITs due to overreactions to expected interest rate increases and certainly over a positive spread compared to ten-year treasury rates. This is expected to continue through the current cycle.
Uncertain policy changes around tax and regulatory reform. This uncertainty seems to have stalled some transaction volume but the expectation is that those changes will have positive effects on the real estate industry, namely expected expansion of credit for real estate development and securitization as well as positive impacts from expected tax reform.
Accounting and tax issues continue to be at the forefront. The revenue recognition and leases standards, two significant accounting pronouncements which will be implemented in the near term, seemed to dominate the accounting issues discussed. Given the pervasive impact to the real estate industry as a whole, this appeared to generate quite a bit of interest during these sessions. Tax reform and further relaxation on FIRPTA seemed to dominate tax discussions.
My biggest takeaway? Industry performance continues with strong funds from operations (FFO) growth in the REIT industry. Uncertainty with respect to tax reform and regulatory reform and modest interest rate increases has tempered some enthusiasm, but is actually elongating this recovery cycle.
PwC | Current developments for the real estate industry 3
These signs continue to point to an extended real estate recovery cycle across asset types and in each major market, with investor preferences still leaning towards housing and industrial which is consistent with industry trends over recent periods. As mentioned, this recovery cycle may be impacted by the policy changes on the horizon, but are expected to have a positive impact on the real estate industry especially once we receive further clarity on the outcome. The sustained success of the real estate industry is exciting, and I am enthusiastic about
2017 and beyond as we are likely to see these trends continue through this current cycle. I’m looking forward to what is ahead of us.
REITWise 2017 covered a variety of topics about the real estate industry. PwC's US Real Estate practice had an opportunity to attend presentations by industry thought leaders and to network with over 200 industry professionals. Read Byron Carlock's insights in his new blog.
II. In the market and recent real estate trends
PwC | Current developments for the real estate industry 5
II. In the market and recent real estate trends
1. Emerging Trends in Real Estate – The Global Outlook 2017 “Real estate de-risks”
The economic and geopolitical concerns evident in Emerging Trends in Real Estate regional reports published in the last quarter of 2016, are if anything more pronounced in the global report. It is striking that while concerns around geopolitics are at unprecedented levels in recent times, confidence in the ongoing flows of capital into real estate remain high.
The consensus was that the current macro-environment of geopolitical uncertainty and fragile economic growth is set to remain a strong feature and real estate will remain in risk-off mode. Global cross border investment into real estate is holding up given the chase for yield and real estate’s position as a safe haven, and there will continue to be a flight to quality by the majority of institutional investors.
‘If protectionism does come through it will take some time to work its way through - many years. It won’t be 2017 phenomena, but the impact will be felt over the next few years.’ Interviewee, Global Emerging Trends in Real Estate 2017.
However, the volume of capital seeking a limited supply of ‘core properties’ is forcing investors to consider new strategies, lowering returns or becoming more active in the operations of their assets. Clearly real estate leaders are thinking carefully about their next steps.
Refer to PwC’s 2017 Emerging Trends in Real Estate – The global outlook for 2017 to read more about trends impacting the real estate industry.
2. Asset & Wealth Management: a new era of growth, disruption and opportunity
In the past 11 years alone, asset managers’ assets under management globally have more than doubled from $37.3 trillion in 2004 to $78.7 trillion in 2015.
Meanwhile, the wealth management industry has expanded rapidly, with Asia-Pacific’s private wealth growing fastest and quickly catching up with Europe’s.
Our 20th Annual Global CEO Survey comes at a time when technology and globalisation are powerful forces of change. It reveals an AWM industry that’s set for growth but also one uneasy about how ready AWM firms are to address the opportunities and challenges these forces will bring. Our client experience, and the CEO interviews showcased in this report, shows some larger firms with their eyes firmly on the future. But the survey also shows many AWM firms planning to continue business as usual.
This contrast may partly be because our sector includes a higher proportion of small firms than the rest of the CEO Survey. Even so, the sector appears slow to innovate and adapt. “Technology is a disruptive force and I am amazed by how low the sector’s survey responses are around digital and cyber security. This industry is not thinking as agilely around technology and disruption as it should. How do customers interact with these firms and how will they want to in the future? When we think of demographic changes with huge wealth transfer where people do not work the same way as their parents – do we even have the right model to address their needs? Some CEOs are looking into this but our survey shows too many of them are not. There’s a real risk of firms being swept aside,” says Barry Benjamin, PwC’s Global Asset & Wealth Management Leader.
This PwC publication discusses key findings in the Asset and Wealth Management industry and reveals an industry that’s confident about its growth, but struggling to adapt to changes in talent, trust, globalization and technology.
PwC | Current developments for the real estate industry 6
3. Recent 7 Day Yield Video Perspectives
PwC has recently released three 7 Day yield videos that discuss topics such as adapting to the new administration, trends in M&A, and drivers of global real estate investment. Refer below to learn more about these topics and the potential impact to your company.
Drivers of global real estate investment, European cash on the sidelines
In this episode of PwC 7 Day Yield, the CFO of Ivanhoe Cambridge, Nathalie Palladitcheff, shares the key drivers behind their real estate
investment strategy. Plus, PwC Luxembourg Asset and Wealth Management Leader, Steven Libby, explores the implications of investors keeping cash on the sidelines amidst continued uncertainty in Europe.
Adapting to the new administration, plus trends in M&A
In this episode of PwC 7 D ay Yield, John Stadtler, PwC US Financial Services Leader, explains how companies can adapt to changing policies with
the new administration, as well as what is top of minds with CEOs; plus Sam Yildirim, PwC US Asset Management M&A Leader, shares the latest trends in M&A and what we can expect to see in 2017.
Brexit and the real estate market
In this episode of PwC 7 Day Yield, Mitch Roschelle sits down with PwC's Global Real Estate Leader, Craig Hughes, to get his perspective on the Brexit vote as
well as current global trends such as infrastructure, interest rates and real estate.
III. Accounting and financial reporting hot topics
PwC | Current developments for the real estate industry 8
III. Accounting and financial reporting hot topics
1. FASB changes how to derecognize nonfinancial assets
ASC 610-20 was issued as part of the new revenue standard. While the revenue standard primarily focuses on contracts with customers, ASC 610-20 was added to provide guidance for recognizing gains and losses from the transfer of nonfinancial assets in contracts with non-customers. The guidance issued by the FASB on February 22, 20171 clarifies when and how to apply ASC 610-20, in certain situations. The new guidance:
Defines “in substance nonfinancial asset”
Unifies guidance related to partial sales of nonfinancial assets
Eliminates rules specifically addressing sales of real estate
Removes exceptions to the financial asset derecognition model
Clarifies the accounting for contributions of nonfinancial assets to joint ventures
The new guidance is the second phase of a broader project. The first phase was completed in January 2017 with the release of ASU 2017-01, Clarifying the Definition of a Business. In the third phase, the FASB may revisit some of the remaining accounting differences between asset and business acquisitions and disposals. To learn more about the FASB changes on how to recognize nonfinancial assets, refer to this PwC In brief.
2. Top 5 Interim reporting reminders
With the calendar year-end reporting cycle behind us, we turn our focus to the interim reporting periods. To help you prepare for the upcoming quarter end, PwC has published a video perspective which provides our Top 5 interim reporting reminders.
In preparing interim financial statements, public companies can assume that users have read the year end audited financial statements. Therefore, disclosures that would substantially duplicate the annual disclosures, such as significant accounting policies are not required. Material contingencies, however, are required whether or not there has been a change.
Interim footnotes should generally focus on items that have significantly changed since year end or events that have occurred since year end. For example, property plant and equipment disclosures and stock based compensation disclosures are not required unless there has been significant activity during the year.
However, certain standards require interim disclosures. In some cases, this disclosure is less than required in annual periods. While segment disclosures are required, companies do not need to include certain elements such as disclosure of major customers.
In other cases, the interim disclosure requirements mirror those of the annual period. For example, the disclosure for fair value measurements and financial instruments are the same for interim and annual periods. To learn more about how required interim disclosures compares and differs from annual periods, refer to PwC’s video perspective.
3. FASB proposal would align the accounting for all share-based payment awards
On March 7, 2017, the FASB proposed guidance that would align the accounting for share-based payment awards issued to nonemployees with the guidance applicable to grants to employees.
Under current GAAP, the accounting for nonemployee share-based payments is significantly different than the guidance for employee awards, particularly with regard to the measurement date and the impact of performance conditions. Under the proposal, entities would apply the existing employee guidance to nonemployee share-based transactions, with the exception of specific guidance related to the attribution of compensation cost.
PwC | Current developments for the real estate industry 9
Additionally, the proposal would align the post-vesting classification (equity or liability) requirements for employee and nonemployee awards, and remove the current requirement to reassess the classification for nonemployee awards upon vesting. It would also give private companies a one-time election to measure liability-classified nonemployee share-based payment awards at intrinsic value instead of fair value. Additionally, private companies would be able to value awards using an industry sector volatility index (referred to as a “calculated value”) if determination of expected volatility is not practicable, consistent with the guidance for employee share-based payment awards.
To learn more the FASB proposal on accounting for share-based payment awards, refer to the PwC In brief
4. Updated valuation standards and a new credential
The use of fair value has become more prevalent in the accounting standards. Correspondingly, due to the judgmental nature, fair value is frequently subjected to regulatory scrutiny as well as audit focus. The valuation profession has been focusing on how to make valuations more reliable and relevant. First, the 2017 International Valuation Standards have been finalized, which include a revised standard on the valuation of intangible assets, as well as two new standards on bases of value and valuation approaches and methods. Next, a new valuation framework and credential has been established, which requires compliance with documentation standards and specifies diligence procedures to be performed on information provided by management.
Refer to PwC’s In depth for a look at current financial reporting hot topics including an update on valuations standards.
5. Distinguishing liabilities from equity: a first step
Companies often enter into financial instruments that straddle the line between liability and equity classification in the financial statements. These instruments are becoming increasingly common and complex as markets evolve. The FASB first added a project related to distinguishing liabilities from equity to its technical agenda in 1986. Since that time, various aspects of this accounting have been revisited multiple times. Today, as financial markets evolve and become more complex, financial instruments are also becoming increasingly complex.
It has been challenging for the accounting standards to keep up with the pace of change. The current literature, although grounded in fundamental concepts, has been subject to multiple patches that addressed narrow issues as they arose, leading to guidance that is more dependent on legal form than economic substance. As a result, the model does not always result in classification that reflects the economics. Given the complexity, the FASB recently solicited feedback on whether it should add a project on distinguishing liabilities from equity to its agenda.
To learn more about the complexities of distinguishing liabilities from equity, refer to the PwC Point of view. Also refer to the recent video perspective which discusses classification of securities with characteristics of both debt and equity.
IV. Update on tax matters
PwC | Current developments for the real estate industry 11
IV. Update on tax matters
1. Net investment hedges may be impacted by recent tax regulations
On December 7, 2016, final regulations were issued under Internal Revenue Code Section 987. The regulations will likely change the way some companies are calculating foreign exchange (FX) translation gains and losses on certain subsidiaries for tax purposes. As a result, the regulation may impact the after-tax cumulative translation adjustment (CTA) account for financial reporting.
The new Section 987 tax regulations impact certain types of entities that own qualified business units (QBUs) (i.e., branches and certain other flow-through entities) that have a functional currency that differs from their owner. Under the new regulations, certain “historic assets” within the QBU, such as land, buildings, plant, equipment, and inventory, are translated for tax purposes at historic FX rates, rather than the current FX rate used under GAAP.
Refer to PwC’s In depth for additional reference to the final regulations under IRC Section 987 and the potential impact on your company.
2. Tax accounting considerations of recent U.S. tax reform
President Trump and the Republican-controlled Congress have indicated that comprehensive tax reform is currently one of the federal government’s top legislative priorities. During his first address to a joint session of Congress, President Trump called for action on U.S. tax reform to “restart the engine of the American economy” and said that his economic team is “developing historic tax reform.” It is widely anticipated that such U.S. tax reform may occur later this year and could result in significant changes to existing U.S. tax law in several areas including corporate tax rates,
business deductions, and international tax provisions. As companies continue to closely monitor developments and assess the implications of potential tax reform, questions may arise as to the financial reporting implications of the various tax reform proposals. To aid in this assessment, we have summarized below key proposals from the tax plans of both President Trump and House Republicans along with related accounting for income tax considerations under U.S. GAAP.
Please refer to the PwC Tax Insights publication to learn more about tax accounting considerations of recent U.S. tax reform. For an in-depth discussion on the outlook for tax policy in 2017 and additional information on recent tax reform proposals, please see PwC’s Washington National Tax Services publications, Decision time for tax reform: 2017 Tax Policy Outlook.
3. Income taxes, uncertain tax positions, disclosures
Disclosures for uncertain tax positions can sometimes be a bit more difficult to pin down than disclosures for other financial statement line items. This is because they often won’t tie out to the tax balances on the financial statements. In this video, PwC explains the accounting framework for uncertain tax positions, identify the related disclosures, and highlight several reasons why the footnote may, or may not, directly agree to the balance sheet.
Every company takes tax positions. A tax position could be whether your company qualifies for a tax deduction or credit, or even whether your company is subject to tax in a certain jurisdiction. Some of these positions might be a stretch, and some may be slam dunks.
Watch PwC’s Video Perspective on Income taxes, uncertain tax positions, and disclosures to learn more.
V. Regulatory considerations
PwC | Current developments for the real estate industry 13
V. Regulatory considerations
1. Casting light on the executive compensation disclosures
In August 2015, the SEC adopted a final rule requiring many public companies to disclose the ratio of their CEO’s annual total compensation to the median annual total compensation of all employees. The pay ratio disclosure is required in filings that require executive compensation disclosures.
In October 2016, the SEC released interpretative guidance on certain aspects of the pay ratio disclosure. The Compliance & Disclosure Interpretations (C&DI) provide some clarity on how companies can begin collecting the information necessary to calculate the pay ratio. The C&DI address:
Selecting a consistently applied compensation measure to identify the median employee
Determining the period used to measure total compensation
Determining the relevant employee population
Subsequent to the release of the C&DI, the SEC issued a request for comment for input on challenges that issuers are experiencing as they prepare for compliance with the pay ratio rule. Companies are encouraged to submit their comments. The comment period ended March 23, 2017.
For more information about this regulatory update, refer to PwC’s The Quarter Close Q1’2017.
2. Home Mortgage Disclosure Act: A sprint to the finish line
Beginning January 1st, 2018, mortgage lenders must begin collecting additional data in accordance with the Consumer Financial Protection Bureau’s (CFPB) new Home Mortgage Disclosure Act (HMDA) rule. While many lenders are making steady progress toward compliance with the new requirements, some lenders are taking a “wait and see” approach due to the uncertainty about the CFPB’s leadership and agenda and the Trump Administration’s regulatory review initiatives.
However, we do not expect to see significant revisions or a reversal of the CFPB’s rule. In fact, the CFPB recently issued its largest-ever fine for violating the existing HMDA requirements. As such, we expect examiners to not only continue to scrutinize reporting practices under the existing requirements, but also to monitor lenders’ progress with implementing the new requirements as part of their ongoing examinations.
Ahead, we take a closer look at the CFPB’s expectations for mortgage lenders during implementation and recommend actions to help mortgage lenders manage compliance risks ahead of examinations. Refer to PwC’s publication on the Home Mortgage Disclosure Act for additional insights. Further, refer to PwC’s Financial Services Regulatory Practice homepage for weekly updates on regulatory and tax matters which may impact your company.
VI. Governance discussion
PwC | Current developments for the real estate industry 15
VI. Governance discussion
1. Why your board should take a fresh look at risk oversight: a practical guide for getting started
In a world of evolving risks and constant regulatory change, boards need a thoughtfully defined approach for overseeing risk. Companies that can depend on their boards to offer guidance and oversight on a variety of risk-related topics are at an advantage. The challenges boards often face when overseeing risk include:
How can a board reassure investors that it is overseeing risk effectively?
Do directors’ backgrounds support effective risk oversight?
Are any key risks falling through the cracks and not being overseen anywhere at the board level?
Is too much of the board-level effort on risk focusing on compliance and regulatory matters? The seven regulatory matters?
To address these challenges, boards can:
Enhance proxy disclosures to describe risk oversight so shareholders can better understand what the board does and how
Rethink board composition. Ensure directors bring diverse perspectives to risk discussions
Clearly allocate risk oversight among the board and its committees. Ensure that the chairs share their committees’ insights about those risks with the full board
Preserve agenda time to focus on key risks, including big picture strategic risks
At a well-run company, boards play a crucial role in risk oversight. Interestingly, almost half of the directors in PwC’s 2016 Annual Corporate Directors Survey indicated that they would like to see their boards devote at least some additional time and focus to risk assessments and risk management. Boards that invest the time to examine and refine their approach to risk oversight can deliver enhanced value to the company and its shareholders.
Refer to PwC’s first module in its Risk Oversight Series, Why your board should take a fresh look at risk oversight: a practical guide for getting started for more insights. The report is the first in a series of publications that will focus on various risk matters. The series offers practical advice on how directors can add value when it comes to risk matters and provides a series of board actions that help directors avoid or overcome common challenges.
2. Shareholder questions: Management’s considerations for 2017 annual meetings
PwC has published a recent CFOdirect publication that is intended to help management and the board of directors prepare for the annual shareholders meeting. It includes example shareholder questions, concise background information on topics that may be top-of-mind for shareholders, and suggested responses management may want to consider in preparing for the annual meeting.
What are the issues shareholders are interested in for the 2017 proxy season? Read our Shareholder questions to learn about issues that might be top-of-mind for shareholders. Refer to this recent PwC Shareholder Questions 2017 publication to learn more.
Additionally, PwC’s Governance Insights Center offers seminars and education events on similar and other relevant governance matters. To learn more about upcoming opportunities in your market and quarterly webcasts refer to the PwC Governance Insights Center homepage.
VII. Technology trends and update
PwC | Current developments for the real estate industry 17
VII. Technology trends and update
1. Payments in the Wild Tech World: Digitization and changing customer expectations
In the last few years, companies in the payments and transaction space have worked towards building an ecosystem that promotes digital payments and reduction in the usage of cash. This has primarily been possible through the use of technology to enhance customer experience. While the traditional players have worked towards creating this ecosystem, it has also been equally (if not more) driven by the new market entrants or the FinTech players who are using technology to make financial services more efficient. The PwC Market Research Center estimates that the number of non-cash transactions will grow by 69% from 2013 to 2020, which would represent over one million transactions happening every minute. However, new industry entrants, the so-called FinTechs, significantly disrupt the traditional payments business and pose serious threats.
In addition, EU governments want to stimulate non-cash payments instruments, enhance security requirements and spur competition with the upcoming Payment Services Directive 2. Pressure from the interchange regulation will result in revenue losses for card issuers.
Given the overlapping nature of business of these players, there has been a growing number of FinTech start-ups and payments providers venturing into partnerships and changing the payments arena, benefiting from the new technologies and market conditions while also leveraging alternative business models that complement traditional payments practices.
Mobile wallets will continue to proliferate globally as the first electronic payments channel for cash-based, previously unbanked segments. These new trends threaten existing incumbent margins and market power. This is why we will continue to see a growth of value-added offerings for new revenue streams and to differentiate against competition. Eventually, we will find a transformed consumer experience associated with shopping and money movement, but it will likely be driven by non-payments incumbents.
There is a need to incorporate advanced tools and technologies to protect consumers from ID theft and fraud. This is a natural tension that is creating a pushpull phenomenon within payments right now: the desire for frictionless transactions on one hand, and increased security measures to prevent fraud and cyber-crime on the other. Enhance proxy disclosures to describe risk oversight so shareholders can better understand what the board does and how
Most payments companies have already put FinTech (to a variable extent) at the heart of their strategies; only 4% of industry players do not yet engage with FinTech. However, with differing business approaches and operational processes, significantly more payments companies (compared to other financial sectors) are launching their own FinTech subsidiaries. This is one way to embrace disruption.
Refer to PwC’s Global Fintech Report to learn more about electronic payments, digitization, and changing customer expectations.
© 2017 PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.
PwC real estate contacts
Byron Carlock
US Real Estate Leader
(214) 754 7580
Brian Ness
Partner, Real Estate Assurance Practice
(646) 471 8365
Tim Conlon
US Real Estate Clients and Markets Leader
(646) 471 7700
Paul Ryan
US Real Estate Tax Leader
(646) 872 1074
Cathy Helmbrecht
US Real Estate Assurance Leader
(214) 754 7988
Tom Wilkin
US REIT Leader
(646) 471 7090
Jeff Kiley
Private Real Estate Equity Leader
(646) 471 5429
Tim Mueller
US Real Estate Advisory Leader
(646) 471 5516
Editorial board
Jordan Adelson
Manager, Real Estate Assurance Practice
(214) 754 7580
Tyler Lewis
Senior Associate, Real Estate Assurance Practice
(646) 471 8070
