FASB 2014 An Appraiser's Guide To Purchase Price Allocation -Final

An Appraiser’s Guide to Purchase Price Allocation forPurchase Price Allocation forFinancial Reporting & TaxPresenters

Justin R. Glasser, MAISenior Manager

Marius W. Andreasen, MAI, CFASenior Managing DirectorSenior Manager

Economic & Valuation ServicesKPMG LLP

g gValuation & Advisory GroupCushman & Wakefield

Moderator

Bill GarberDirector of Government andDirector of Government and External Relations Appraisal Institute

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Disclaimer

The views expressed in today’s webinar doThe views expressed in today s webinar do not necessarily reflect the official position of the Appraisal Institute.

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Introduction - Presenters

Justin is currently a senior manager in the Valuation Services practice of KPMG LLP. He islocated in the firm’s San Diego office where he assists in the preparation of real propertyappraisals, highest and best use studies, lease analyses, and purchase price accounting oft ibl t l ti t i l d id ti l l t t i l di i tl ttangible assets relating to commercial and residential real estate including: gaming outlets,hotels, destination resorts, master planned communities, manufactured home communities,major office buildings, manufacturing and distribution facilities, retail developments, restaurants,banks, movie theaters, and undeveloped land. He also performs transfer pricing studies relatingto qualified properties and the real property leases held between REITs and taxable REITsubsidiaries.

Justin R. Glasser, MAI He has performed valuations of development lands in Central America and the Caribbean,including Belize, Haiti, Island of St. Kitts, and Island of Petite St. Vincent. Also, Justin hasprovided valuation services related to lost profits associated with timeshare points and propertieslocated in California, Hawaii, and Mexico for purpose of litigation. Other litigation support includesvaluation services related to real property assets located throughout California.

Clients served by Justin include lending institutions, hospitality companies, insurance companies,

Senior Manager

KPMG LLP4747 Executive DriveSuite 600San Diego, CA 92131

Tel 858-750-7207Fax 858-430-9652Cell 619-723-6110 y g , p y p , p ,

pension fund advisors, REITS, government agencies, developers, corporations, and attorneys.

Representative Clients Hilton Hotels Corporation

MGM Mirage

The Blackstone Group

Cornerstone Real Estate Advisors

GEM R lt C it l

Bascom

Armada Hoffler

C it l P ti

Cell 619 723 [email protected]

Functions and Specializations Real Property Transfer Pricing Litigation Support

Education, Licenses, Certifications, & Panels Masters of Science in Real Estate, University of San Diego

G Si Al h A d R i i t Dubai World

Starwood Hotels & Resorts Worldwide

Hyatt Corporation

Luxury Resorts & Hotels

Westport Capital Partners

GEM Realty Capital

UBS Realty Investors

ING Investment Management

IMH Financial Corporation

Kiawah Development Partners

Capital Properties

Pillar Communities

RedHill Realty Investors

The Blackstone Group

CBRE Global Investors

Gamma Sigma Alpha Award Recipient B.A. in Economics, University of California at San Diego Member, Appraisal Institute, MAI Designation #497209 Appraisal Institute Government Relations Committee 2013-Present Appraisal Institute Panel Member for IVS for Real Estate in 2013 Appraisal Institute Panel Member for Financial Reporting in 2012 Appraisal Institute Associate Committee Chair in 2011 State of Arizona License # 31944 State of California License # AG045014 State of Colorado License #CG100042083 State of Florida License # RZ3544

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Harrah’s Entertainment

Tropicana Entertainment

Fedinco

Archstone

State of Michigan License # 31944 State of Oregon License #C001151 State of Pennsylvania License # GA004001 State of Texas License # 1380207 State of Utah License # 8548636-CG00 State of Washington License # 1102240

Introduction - Presenters

Mr. Andreasen is a Senior Managing Director and Americas Practice Leader of the Financial ReportingPractice within the Valuation & Advisory (V&A) Group at Cushman & Wakefield. The FinancialReporting Practice is a specialty within V&A focusing on corporate engagements involving real estaterelated consulting services with a primary focus on valuation for financial reporting fair valuerelated consulting services, with a primary focus on valuation for financial reporting, fair valuemeasurement (ASC Topic 820) and purchase price allocations (ASC Topic 805), intangible real estateassets, fractional/minority interests in real estate holding companies and partnerships, real estate-related going concern enterprises and real estate investment trusts (REITs), and valuations ofinvestments across the capital stack including, equity, preferred equity, and mezzanine and seniordebt.

Mr Andreasen has worked on a national and international level with services provided from coast toMarius W. Andreasen, MAI, CFA

Mr. Andreasen has worked on a national and international level, with services provided from coast tocoast in the United States, while also performing real estate valuations and consultations withinMexico, Canada, India, Ireland, Aruba, and the Commonwealth of the Bahamas. These valuations andconsultations have been on a variety of assets, including office buildings, regional malls, neighborhoodand community shopping centers, hotels and destination resort properties, golf courses, conveniencestores and gas stations, apartment complexes, transportation rights-of-way, solar photovoltaic plants,data centers, hospitals, subdivision developments, and a variety of industrial facilities including singleand multi-tenant distribution heavy manufacturing research & development facilities and cold-storage

Senior Managing Director &Americas Practice Leader, Financial Reporting

Cushman & Wakefield of Illinois, Inc.South Wacker DriveSuite 2800Chicago, Illinois 60606

Tel 312 470 1881 and multi tenant distribution, heavy manufacturing, research & development facilities, and cold storagewarehouses. These studies have been in conjunction with real estate portfolio and joint-venturevaluations, merger and acquisition due diligence support, asset impairment studies, internal planning,highest and best use analysis, financing, litigation support, sale-leasebacks, fresh start accounting, andestate planning.

Over the past decade Mr. Andreasen has provided valuation and consulting services on more than $60billion in transactional value, having performed numerous studies assisting public and private REIT

Tel 312-470-1881Mobile [email protected]

Functions and Specializations Valuation Buy-Side Advisory Financial Reporting Litigation Support Fractional Interest Valuations Debt Valuations , g p g p p

clients in the application of FASB Statement No. 141R / ASC Topic 805 (Business Combinations),FASB Statement No. 159 / ASC Topic 820 (Fair Value Measurements and Disclosures) and ASC Topic852 (Reorganizations). Furthermore, Mr. Andreasen has extensive experience advising some of thelargest U.S. pension funds with regard to their real estate and infrastructure fund investments. Overthe past several years Mr. Andreasen has valued equity interests in funds which, in aggregate, totalmore than $7 billion in assets under management, and span across all property types and investmentstrategies, ranging from stabilized core assets to Greenfield infrastructure investments.

Debt Valuations

Education, Licenses, Certifications B.S. in Finance, University of Illinois at Urbana Champaign Member, Appraisal Institute, MAI Designation #12432 Chartered Financial Analyst (CFA) Member of the CFA Society of Chicago International Valuation Standards Council (IVSC) Cushman & Wakefield Leadership Council, Board of Advisors Guest lecturer, University of Illinois at Urbana-Champaign Appraisal Institute Government Relations Committee 2013-Present

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g g g Appraisal Institute Government Relations Committee 2013 Present Certified General Real Estate Appraiser in numerous states

DISCLAIMER

DISCLAIMER:

The processes presented in the following slides are consistent with generally accepted accounting principles (GAAP) and guidance published by theaccepted accounting principles (GAAP) and guidance published by the Financial Accounting Standards Board (FASB).

“A reporting entity shall use valuation techniques that are appropriate in the circumstances and for which sufficient data are available to measure fair

l i i i th f l t b bl i t d i i i i thvalue, maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs.” (ASC 820-10-35-24A)

“Three widely used valuation techniques are the market approach, cost approach, and income approach….An entity shall use valuation techniques consistent with one or more of those approaches to measure fair value.” (ASC 820-10-35-24A)

However, there is no Security and Exchange Commission (SEC) rule mandating a specific valuation technique to comply with financial reporting in

d ith ASC 805 B i C bi tiaccordance with ASC 805, Business Combinations.

This presentation reflects years of collaboration between the valuation and audit community, as well as the study of public comment letters sent to the SEC and private letter rulings issued by the SEC. However, variations exist

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p g yacross reporting entities and among service providers.

Overview

Introduction to FASBA B i f Hi t f ASC 805 A Brief History of ASC 805

User Profile Standard of Value Market Value v. Fair Value Highest and Best Use (USPAP v. ASC 820) Value Premise (In-Use v In-Exchange) Value Premise (In-Use v. In-Exchange) Process (Step-by-Step) For Investment Properties Case Study (Office) Common Pitfalls and Mistakes IRC § 1060 Q&A

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Introduction to FASB

Financial Accounting Standards Board (FASB)

Independent Private Organization Created 1973

Governs Financial Reporting (Public & Non-Public)• Securities Exchange Commission• American Institute of Certified Public Accountants

Maintains Standards Maintains Standards• FASB Accounting Standards Codification (ASC)

– e.g., ASC 805, Business Combinations

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A Brief History of FASB Standards

(1970) APB Opinion No. 16, Business Combinations Pooling Interests Method or Purchase Method (Cost Allocation)

• Pooling Method led to inconsistencies across financial statements

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Pooling vs. Purchase Accounting Prior to 2001 companies could structure acquisitions to determine thePrior to 2001, companies could structure acquisitions to determine the

choice between accounting methods: purchase accounting or pooling-of-interests accounting Pooling: Combine book value of assets and liabilities of the two companies to

t th b l h t f th bi d icreate the balance sheet of the combined companies Example: Company A acquires Company B for $650 in stock. Equity book value

is $50. Excess purchase price attributed to increased value of PP&E (over depreciated historical cost book value), plus value of intangibles (brand, patents, licenses etc )licenses, etc.)

Balance Sheet, Pooling MethodPurchase A+B Purchase

Company A Company B A+B Pooling Adjustments AccountingCurrent Assets 200 100 300 0 300Current Assets 200 100 300 0 300Property, Plant & Equipment 500 50 550 100 650Intangibles 0 0 0 500 500Total Assets 700 150 850 600 1450

Current Liabilities 100 50 150 150Long Term Liabilities 200 50 250 250

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Long-Term Liabilities 200 50 250 250Stockholder's Equity 400 50 450 600 1050Total Liabilities & Equity 700 150 850 600 1450


The Pooling Method led to inconsistencies across fi i lfinancial statements…

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(2001) SFAS 141, Business Combinations Elimination of Pooling Interests Method & Amortization of Goodwill Purchase Method only (Single Approach)

• Transaction Costs Included in Cost Allocation

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(2007) SFAS 141R B i C bi ti (2007) SFAS 141R, Business Combinations Clarification of accounting methods

• Transaction Costs Expensed and Excluded from Allocation

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(2007) SFAS 141R B i C bi ti (2007) SFAS 141R, Business Combinations Clarification of accounting methods

• Transaction Costs Expensed and Excluded from Allocation

(2009) ASC 805, Business Combinations Emphasis on Fair Value

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A Brief History of FASB Standard

ASC 805, Business Combinations mandates that “an acquiring entity shall allocate the cost of an acquired entity to the assetsentity shall allocate the cost of an acquired entity to the assets acquired and liabilities assumed based on their estimated fair values at date of acquisition.” Furthermore, the acquiring entity shall “…identify all assets acquired and liabilities assumed,shall …identify all assets acquired and liabilities assumed, including intangible assets that meet [either of] the recognition criteria, regardless of whether they had been recorded in the financial statements of the acquired entity.”q y

Contractual-Legal Criterion – Asset(Liability) arises from contractual or other legal rights (regardless of whether they can be transferred or separated)p )

Separability Criterion – Asset(Liability) capable of being separated from acquired entity(property), or can be sold in combination with a related contract, asset or liability

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y

ASC 805, Business Combinations

Definition of Business Combination A transaction or other event in which an Acquirer obtains

control of one or more businesses. A business is defined as an integrated set of activities and

assets that is capable of being conducted and managed forassets that is capable of being conducted and managed for the purpose of providing a return.

Initial Acquisition Accounting Identify Acquirer (usually evident) Recognition and Measurement

• Assets Acquired (e.g., building, building lease intangibles)• Liabilities Assumed (e.g., debt)Liabilities Assumed (e.g., debt)• Fair Value Measurement (excludes transaction costs)

Acquirer may perform analysis “in-house” Acquirer has up to one year to finalize analysis

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Take away…

“Why should I care about any of this?”

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Take away…

Your clients careYour clients care….

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Take away…

and many are already using your…and many are already using your reports to comply with ASC 805.

(You may not even know it!)

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User Profile - Overview

Public Companies REITs

• Industrial• Office

• Lodging• Healthcare (e.g., assisted living)Office

• Retail• Apartment

Oth ( h i d)

Healthcare (e.g., assisted living)• Manufactured Home Communities• Single Family REITs

Others (when acquired)

P i t C iPrivate Companies Looking to go public

• Requires four years audited financials

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Requires four years audited financials

User Profile – Walgreen Co.

Walgreen Co., together with its subsidiaries, operates the largest drugstore chain in the United States with net sales of $72.2 billion in the fiscal year ended August 31, 2013. It provides customers with convenient access to consumer goods and services pharmacy andconvenient access to consumer goods and services, pharmacy, and health and wellness services in communities across America.

Walgreen Co. was incorporated as an Illinois corporation in 1909 as a successor to a business founded in 1901 The Company is principallysuccessor to a business founded in 1901. The Company is principally in the retail drugstore business and its operations are within one reportable segment.

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User Profile – Walgreen Co.

“…allocation of thepurchase price accounted

“assets…recorded at their acquisition date f i l ”for under the purchase

method of accounting…”fair values…”

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• 2010 Annual Report, Page 31, Note 4, Acquisitions….

User Profile - Spirit Realty Capital

Spirit Realty Capital (Spirit) is a self-administered Real Estate Investment Trust (REIT) company located in Scottsdale, Arizona. It invests primarily in single tenant (generally) free standinginvests primarily in single tenant, (generally) free-standing, commercial real estate facilities where tenants conduct retail, service, or distribution activities.

Spirit began operations through a predecessor legal entity in 2003Spirit began operations through a predecessor legal entity in 2003. Spirit became a public company in December 2004 and were subsequently taken private in August 2007 by a consortium of private investors. On September 25, 2012, Spirit completed an initial public offering (the “IPO”) of 33.4 million shares of common stock.

As of December 31 2012, Spirit held investments throughout the United States and its portfolio of properties was leased to

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approximately 165 tenants.


On July 17, 2013, Spirit completed the acquisition of Cole Credit Property Trust II, Inc. ("Cole II") through a transaction in which it merged into the Cole II legal entity and was renamed Spirit Realtymerged into the Cole II legal entity and was renamed Spirit Realty Capital, Inc. As a result, Cole II was the "legal acquirer" in the Merger for certain legal and regulatory matters and Spirit Realty Capital was deemed the "accounting acquirer" in the Merger for other legal and regulatory matters. The merger resulted in a post-closing enterprise value of $7.4 billion.

Exclusive of the Cole II Merger, Spirit acquired another 194 properties for a gross investment of $408.6 million in 40 transactions during.

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Purchase Accounting and Acquisition of Real Estate When acquiring a property for investment purposes, we allocate the purchase price to

land building improvements and equipment based on their relative fair values Forland, building, improvements and equipment based on their relative fair values. For properties acquired with in-place leases, we allocate the purchase price of real estate to the tangible and intangible assets and liabilities acquired based on their estimated fair values. In making estimates of fair values for this purpose, we use a number of sources, including independent appraisals and information obtained about each property as a result our pre-acquisition due diligence and its marketing and leasing activitiesresult our pre acquisition due diligence and its marketing and leasing activities.

Lease Intangibles Lease intangibles represent the value of in-place leases and above- or below-market

leases. In-place lease intangibles are valued based on an estimates of costs related to tenant acquisition and the carrying costs that would be incurred during the time it would take to locate a tenant if the property were vacant, considering current market conditions and costs to execute similar leases at the time of the acquisition.

• 2013 Annual Report Page 48

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• 2013 Annual Report, Page 48


Spirit Realty Capital - Diversification By Tenant

Tenant Number ofProperties

Percentage ofTotal RevenueProperties Total Revenue

Shopko Stores/Pamida Operating Co., LLC 181 14.8%Walgreen Company 69 4.4%84 Properties, LLC 109 3.5%Church's Chicken 201 2 6%Church s Chicken 201 2.6%Academy Sports + Outdoors 9 2.3%Circle K 83 2.2%CVS Caremark 37 1.8%CarMax, Inc 9 1.5%Carmike Cinemas Inc 12 1 5%

Located in49 states

Carmike Cinemas, Inc. 12 1.5%Rite Aid 30 1.4%Other 1,301 64.0%

Total 2,041 100.0%

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• 2013 Annual Report, Page 35

Standard of Value

The standard of value for purchase price allocation in accordance with ASC 805 is Fair Value (as defined by ASC 820, Fair Value Measurements).defined by ASC 820, Fair Value Measurements).

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Market Value v. Fair Value

Market Value: The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each q , yacting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:p g y y Buyer and seller are typically motivated; Both parties are well informed or well advised and acting

in what they consider their best interests;A bl ti i ll d f i th A reasonable time is allowed for exposure in the open market;

Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; andg p ;

The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale

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the sale.• Per Dictionary of Real Estate Appraisal (Fifth Edition)


Fair Value: The price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly t ti b t k t ti i t t th ttransaction between market participants at the measurement date. (ASC 820-10-35-2)

A fair value measurement assumes that the transaction t ll th t t f th li bilit t k l ithto sell the asset or transfer the liability takes place either in the principal market or most advantageous market. (ASC 820-10-35-5)

In all cases, a reporting entity shall maximize the use ofIn all cases, a reporting entity shall maximize the use of relevant observable inputs and minimize the use of unobservable inputs to meet the objective of a fair value measurement. (ASC 820-10-35-16AA)

In many cases, the transaction price (entry price) will equal the fair value (exit price). (ASC 820-10-30-3)

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• Per ASC 820, Fair Value Measurements


In other words….

Fair value, as defined by ASC 820, Fair Value Measurements, and market value are very similar in many respectsmany respects.

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Highest and Best Use (USPAP v. ASC 820)

Under Uniform Standards of Professional Appraisal Practice (USPAP)…( )

• When necessary for credible assignment results in developing a market value opinion, an appraiser must develop an opinion of the highest and best use of the realdevelop an opinion of the highest and best use of the real estate. (Standards Rule 1-3b)

• Specifically, “an appraiser must analyze the relevant legal, h i l d i f t ”physical, and economic factors…” (Standards Rule 1-3b)

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According to ASC 820, Fair Value Measurements…• A fair value measurement of a nonfinancial asset takes into• A fair value measurement of a nonfinancial asset takes into

account a market participant’s ability to generate economic benefits by using the asset in its highest and best use or by selling it to another market participant that would use theselling it to another market participant that would use the asset in its highest and best use. (ASC 820-10-35-10A)

• The highest and best use of a nonfinancial asset takes into account the use of the asset that is physically possibleaccount the use of the asset that is physically possible, legally permissible, and financially feasible. (ASC 820-10-35-10B)

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In other words….

Highest and Best Use, as defined by ASC 820, Fair Value Measurements, and highest and best use as referenced in USPAP are very similar in manyreferenced in USPAP are very similar in many respects.

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However, there is (at least) one significant difference…

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According to ASC 820, Fair Value Measurements…• Highest and best use is determined from the perspective of• Highest and best use is determined from the perspective of

market participants, even if the reporting entity intends a different use. However, a reporting entity’s current use of a nonfinancial asset is presumed to be its highest and bestnonfinancial asset is presumed to be its highest and best use unless market or other factors suggest that a different use by market participants would maximize the value of the asset. (ASC 820-10-35-10C)

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In other words….

The highest and best use of an asset, as defined in section ASC 820-10-35-10C, establishes the valuation premise (i e in-exchange or in-use) usedvaluation premise (i.e., in-exchange or in-use) used to measure the fair value of an asset in accordance with ASC 805, Business Combinations.

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Value Premise (of Nonfinancial Assets)

In-Use Premise

The highest and best use of a nonfinancial asset might provideThe highest and best use of a nonfinancial asset might provide maximum value to market participants through its use in combination with other assets as a group (as installed or otherwise configured for use) or in combination with other assets and liabilities (for example, a business). (ASC 820-10-35-10Ea)

In-Exchange Premise

The highest and best use of a nonfinancial asset might provide maximum value to market participants on a standalone basis. If the highest and best use of the asset is to use it on a t d l b i th f i l f th t i th i th tstandalone basis, the fair value of the asset is the price that

would be received in a current transaction to sell the asset to market participants that would use the asset on a standalone basis). (ASC 820-10-35-10Eb)

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) ( )

In-Use v. In-Exchange

Exit Market =

Buyers of the Companyy p y

In-Use Premise

Fair Value may exceed Market Value

E it M k tExit Market =

Buyers of Real Estate (Stand-Alone)

In Exchange PremiseIn-Exchange Premise

Fair Value (generally) consistent with Market Value

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Exit Market = Buyers of the Company

Scenario 1:Company Value = $30 million

Real Estate Market Comps = $10 millionReplacement Cost (less Physical & Functional Obsolescence*): $15 million*external obsolescence considered based on business enterprise

Fair Value In-Use exceeds Market Value

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Exit Market = Buyers of Real Estate (Stand-Alone)

Scenario 2:Company Value = $30 million

Real EstateMarket Comps = $50 million

Fair Value In-Exchange (i.e., Market Value) exceeds Fair Value In-Use

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Take Away….

The standard of value employed under ASC 805 i f i l ( d fi d b ASC 820)is fair value (as defined by ASC 820).

The fair value of an asset acquired as part of a going concern is the greater of “In Use” or “Ingoing-concern is the greater of “In-Use” or “In-Exchange” value.

The fair value of a stand-alone asset (i e The fair value of a stand-alone asset (i.e., investment property) is based on an “In-Exchange” Premise.

Under the “In-Exchange” Premise fair value is generally consistent with market value.

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Process (Step-by-Step) – Investment Property

Step 1: Validate Purchase Price (‘As Is’ fair value).

St 2 D t i “A If V t” f i l f t Step 2: Determine “As-If-Vacant” fair value of property.

Step 3: Allocate the “As-If-Vacant” fair value to land, building, site improvements, and FF&E.

Step 4: Calculate remaining purchase price to allocate Step 4: Calculate remaining purchase price to allocate.

Step 5: Allocate a portion of remainder (calculated in Step 4) to above- and below- market leases (leasehold assets and liabilities).

Step 6: Allocate a portion of remainder (calculated in Step 4) to ‘Lease-In-Place’.Step 6: Allocate a portion of remainder (calculated in Step 4) to Lease In Place .

Step 7: Allocate a portion of remainder (calculated in Step 4) to tenant (customer) relationships, if applicable.

Step 8: Calculate cash equivalency of assumed debt, if applicable, and allocate a yportion of remainder (calculated in Step 4) to debt asset/liability.

Step 9: Reconcile fair value estimates and allocate remaining (intangible) value, if any, to goodwill.

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Process (Step 1) – Investment Property

Step 1: Validate Purchase Price (‘As Is’)

Standalone Transactions• Arm’s Length• Adequate ExposureAdequate Exposure• All Cash (or Equivalent)• Orderly Transaction

– Typically some sort of benchmarking is requisite

Others (i.e., Portfolio, Off-market, Related Party)• Income Producing Properties

– Income Approach (DCF Method)» Estimate should be within 5% of Purchase Price» Estimate should be within 5% of Purchase Price» Options should be considered» Excess land valued separately (via Market Approach) and added to ‘As

Is’ value estimate• Asset Acquisition

Market Approach

Slide 47

– Market Approach


Step 2: Determine “As-If-Vacant” fair value

Income Approach– Discounted Cash Flow Method– Direct Capitalization w/ Lease Up Deductions

Considerations– Consistency with ‘As Is’ assumptions in evaluating intangible

assets» Hold period» TI Allowance» Leasing Commissions» Absorption/Downtime

– Excess land valued separately (via Market Approach)

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Step 3: Allocate the “As-If-Vacant” fair value to land building site improvements and FF&Eland, building, site improvements, and FF&E. Cost Approach

• Land (Market Approach)– Can be a significant challenge, especially for large assets in dense, g g , p y g ,

urban environments.– Goodwill residual v. Land Residual proponents

• Building & Site Improvements (RCNLD)– Replacement Cost New Less Depreciation (RCNLD)– Calculating the building fair value as a residual (i e As If Vacant Value less Land– Calculating the building fair value as a residual (i.e., As If Vacant Value less Land

Value) is prohibited– The ‘As-If-Vacant’ value (from income approach) is used to benchmark the

RCNLD (rule of thumb ± X percent)

• FF&E (Market Approach or RCNLD)– Many transactions may not include FF&E, or entity may account for it separately.y y , y y p y

Reconciliation• Cost Approach & Income Approach (As-If-Vacant)

– Variance ± X percent (rule of thumb)– Results from Cost Approach utilized for allocation

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Step 4: Calculate remaining purchase price to ll tallocate.

Subtract ‘As-if-Vacant’ fair value from purchase price• Remainder reflects fair value of intangibles

– Above / (below) market leases– Lease-In-Place (cost avoidance)

» Lost income during lease upb• Rent + Reimbursements

» Tenant Improvement Allowances» Commissions» Legal & Marketing expense

Tenant (Customer) Relationships (if applicable)

Lease origination costs

– Tenant (Customer) Relationships (if applicable)– Debt Asset/Liability (if applicable)– Goodwill (if applicable)

» Goodwill v. Land Residual debate

Slide 50


Step 5: Allocate a portion of remainder (calculated in Step 4) to above- and below- market leases.

Income Approach$7 00

$7.25

$7.50

$7.75

• Estimate market rent• Forecast contract rent• Forecast market rent

$5 25

$5.50

$5.75

$6.00

$6.25

$6.50

$6.75

$7.00

Ren

t ($/

SF)

Contract Rent

Market Rent

• Subtract forecast market rent from contract rent

• Present value cash flow variance Period 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023Contract Rent 5.00 5.00 5.50 5.50 5.50 5.50 5.50 6.00 6.00 6.00 6.00 6.00M k t R t 5 75 5 89 6 04 6 19 6 35 6 51 6 67 6 83 7 01 7 18 7 36 7 54

$4.50

$4.75

$5.00

$5.25

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

Year

• Considerations– Options (assume exercised if below market)

» “significant economic compulsion” = 10%?, 5%?, ???» Case Study: Cedar Realty Trust

Market Rent 5.75 5.89 6.04 6.19 6.35 6.51 6.67 6.83 7.01 7.18 7.36 7.54Difference -0.75 -0.89 -0.54 -0.69 -0.85 -1.01 -1.17 -0.83 -1.01 -1.18 -1.36 -1.54

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y y– Expense reimbursements– Materiality Thresholds (start/end dates, percent variance)


Step 5: Allocate a portion of remainder (calculated in Step 4) to above- and below- market leases.

Point of Debate• Contract Escalations vs. Market Inflation• Example:

– Grocery anchor signed today for 20 year term, $10/SF with no escalations– Market standard is that similar leases would be signed without any escalations– Assume annual market inflation is 3% per year (over the long-run projection)– Is the flat lease a favorable lease to the tenant?– Is the flat lease representative of market terms?

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Step 6: Allocate a portion of remainder (calculated in Step 4) to ‘Lease-In-Place’.

Think of it as “cost avoidance”L I Pl i l d (f l ) Lease-In-Place includes (for example)

• Leasing Commissions• Legal & Marketing Costs• Downtime• Rent Abatements• Expense Reimbursement• Lost Rent • Tenant Improvement Allowancee a p o e e o a ce

Pro Rata Remaining Lease Term

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Step 6: Allocate a portion of remainder (calculated in Step 4) to ‘Lease-In-Place’.

Point of DebateSale Leaseback Transaction• Sale-Leaseback Transaction

• For a sale-leaseback, is there a LIP intangible?• Technically, the lease is signed after the asset is purchased (not “in-place” at

the time of purchase)The economics of the transaction are impacted b the leaseback agreement• The economics of the transaction are impacted by the leaseback agreement (most likely the purchase does not occur without the leaseback arrangement)

• Does this meet one of the two intangible asset requirements?Contractual-Legal Criterion Asset(Liability) arises from contractual or– Contractual-Legal Criterion – Asset(Liability) arises from contractual or other legal rights (regardless of whether they can be transferred or separated)

– Separability Criterion – Asset(Liability) capable of being separated from acquired entity(property), or can be sold in combination with a

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q y(p p y)related contract, asset or liability


Step 7: Allocate a portion of remainder (calculated in Step 4) to tenant (customer) relationships, if applicable. An existing relationship with a customer/tenant may giveAn existing relationship with a customer/tenant may give

rise to intangible value to the acquirer in that there may be cost savings associated with the relationship (e.g., the potential reduced expenditure arising from the renewal of an in-place tenant).

• Probability-weighted present value of future expected cost savings driven by the relationship (avoided downtime between leases, avoided TI allowance, etc.))

In practice, we do not typically see a value assigned to tenant relationships. This is an advanced concept which falls outside the scope of our discussion today.

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Step 8: Calculate cash equivalency of yassumed debt, if applicable. Accounts and notes payable, long-term debt, and other

claims payable must be assigned amounts “at presentclaims payable must be assigned amounts at present values of amounts to be paid determined at appropriate current interest rates.”

If a mortgage is assumed in the acquisition of a property, g g q p p ythere may be an intangible asset to the extent that the assumed mortgage features a below market coupon.

Likewise, assumed mortgages which feature above market coupons represent an assumed liability to the buyer.

This is an advanced concept which falls outside the scope of our discussion today.

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Step 9: Reconcile fair value estimates and allocate remaining (intangible) value, if any, to goodwill. Variance Greater Than 5 percent? (Or should it be 3 percent?) Variance Greater Than 5 percent? (Or should it be 3 percent?)

• In the event the sum of the allocated fair value estimates for land, building & site improvements, and intangibles exceeds or falls short of the purchase price by more than 5 percent, this may be indication of goodwill

b i h h h ld i it ti b for a bargain purchase; however, one should revisit assumptions before making this conclusion.

Variance Less Than or Equal to 5 (or 3?) percent?• In the event the sum of the allocated fair value estimates for land, building , g

& site improvements, and intangibles or falls at or within 5 percent of the purchase price, a pro rata adjustment (push factor) is made to the fair value estimates (with the exception of debt/financial instruments) to reconcile to the purchase price.

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Case Study (Office)

Transaction Overview

Sale Price $36,150,000 Sale Date 8/7/2013

Property Characteristics

Type OfficeClass CYear Built 1997Gross Building Area (SF) 215,688 Parking Structure (SF) 297,000 Site Area 62,006 Rentable Area (SF) 147,447 Construction Type Concrete/Steel FrameNumber of Stories 9

S ( ) 3 11Land Size (Acres) 3.11 Land Size (SF) 135,472

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Case Study (Office)

FairValue

Step 1: Validate Purchase Price (‘As Is’). Standalone Transaction

Net Purchase Consideration to be Allocated: $ 36,150,000

As-Is 36,150,000 Variance 0.00%

Tangible Assets

• Arm’s Length• Adequate Exposure• All Cash (or Equivalent)

As-Vacant -

Land -Building Improvements -Site Improvements -

Total Tangible Assets -

• Orderly Transaction– No. Typically some sort of

benchmarking is requisite

Intangible Assets

Leasehold (Building)Total Advantage -Total Disadvantage -Total -

In Place Lease -

Total Intangible Assets -

Total Assets Allocated $ -

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Case Study (Office)

FairValue

Net Purchase Consideration to be Allocated: $ 36 150 000Net Purchase Consideration to be Allocated: $ 36,150,000

As-Is 36,150,000 Variance 0.00%

Tangible Assets

A V t 30 890 000

Step 2: Determine “As-If-Vacant” fair value.As-Vacant 30,890,000

Land -Building Improvements -Site Improvements -


Intangible Assets


In Place Lease -



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Case Study (Office)

FairValue


As-Is 36,150,000 Variance 0.00%

Tangible Assets

As-Vacant 30 890 000

Step 3: Allocate the “As-If-Vacant” fair value to land…

As Vacant 30,890,000

Land 2,992,263 Building Improvements -Site Improvements -


Intangible AssetsIntangible Assets


In Place Lease -



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Case Study (Office)

FairValue


As-Is 36,150,000 Variance 0.00%

Tangible Assets

As-Vacant 30 890 000

Step 3: …and to building and site improvements.

As Vacant 30,890,000

Land 2,992,263 Building Improvements 26,418,467 Site Improvements 227,668

Total Tangible Assets 29,638,398

Intangible AssetsIntangible Assets


In Place Lease -



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Case Study (Office)

FairValue


As-Is 36,150,000As Is 36,150,000 Variance 0.00%

Tangible Assets

As-Vacant 30,890,000

Land 2 992 263Land 2,992,263 Building Improvements 26,418,467 Site Improvements 227,668


Intangible Assets

Step 4: Calculate remaining purchase price to allocate.


In Place Lease -

$36,150,000 -$29,638,398 = $6,511,602



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Case Study (Office)

FairValue


As-Is 36,150,000 Variance 0.00%

Tangible Assets

As-Vacant 30 890 000As Vacant 30,890,000



Intangible Assets

Step 5: Allocate a portion of remainder ( l l t d i St 4) t b d

Intangible Assets

Leasehold (Building)Total Advantage 810,354 Total Disadvantage (248,265)Total 562,089

(calculated in Step 4) to above- and below- market leases.

In Place Lease -

Total Intangible Assets 562,089


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Case Study (Office)

Step 5 – Detailed LookTenant Name: Appraisal InstituteSquare Feet 4,547Square Feet 4,547 End Date 4/18Remaining Months 57 Partial Year

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Contract Base Rent ($/SF) 20.91 21.33 21.76 22.19 16.89 - - - - -Contract Reimbursement ($/SF) 8.45 8.57 8.88 9.15 6.91

29.36 29.90 30.64 31.34 23.80 - - - - -

Market Rent 22.50 23.18 24.33 25.55 19.74 - - - - -Market Reimbursement ($/SF) 8.57 8.69 8.94 9.22 6.97

31.07 31.87 33.27 34.77 26.71 - - - - -

Variance ($/SF) (1.71) (1.97) (2.63) (3.43) (2.91) - - - - -% -5.50% -6.18% -7.91% -9.86% -10.89% - - - - -Refined Variance ($) -7,775 -8,958 -11,959 -15,596 -13,232 - - - - -

Discount rate 8.25%PV Variance ($44,515)PV Contract Rent $525,765 % Contract Rent -8%

Don’t forget generally accepted materiality thresholds….• Exclude leases with start/end dates within (x) months of Acquisition Date• Exclude leases with variance within (x) percent of (contract or market) rent

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Case Study (Office)

FairValue


As-Is 36,150,000 Variance 0.00%

Tangible Assets

As-Vacant 30,890,000 , ,



Intangible Assets

Step 6: Allocate a portion of remainder

Intangible Assets

Leasehold (Building)Total Advantage 810,354 Total Disadvantage (248,265)Total 562,089

I Pl L 5 549 514 Step 6: Allocate a portion of remainder (calculated in Step 4) to ‘Lease-In-Place’.

In Place Lease 5,549,514

Total Intangible Assets 6,111,603

Total Assets Allocated $ 35,750,001

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Case Study (Office)

Step 6 – Detailed Look

Lease-In-Place includes (for example) Leasing Commissions Legal & Marketing CostsLegal & Marketing Costs Downtime Rent Abatements Expense ReimbursementExpense Reimbursement Lost Rent Tenant Improvement Allowance

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Case Study (Office)


Leasing Commissions

Legal & Marketing Costs

(i)

SF Leasing Commission

Legal & Marketing

RUL (Months)

Market Terms (Months)

Remaining %Market Term Total Leasing Cost

( ) (b) ( ) (d) ( ) (f) (d) / ( ) (g) =(a) (b) (c) (d) (e) (f) = (d) / (e) (g) (c) * (f) * Rent + (a) * (b) * (f)

4,547 $5.00 3.0% 57 60 95.0% $ 36,583

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Case Study (Office)


Downtime

Rent AbatementsRent Abatements

Expense Reimbursement

(ii)

SF Downtime (Months)

Rent Abatement (Months)

Downtime + Abatement

RUL (Months)

Monthly Expenses

Total Reimbursement

Revenue

(a) (b) (c) (d) = (b) + (c) (e) (f) (g) = (d) * (f)(a) (b) (c) (d) (b) (c) (e) (f) (g) (d) (f)

4,547 6.0 4.0 10.0 57 $ 8.45 $ 84.50

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Case Study (Office)


Lost Rent

(iii)(iii)

SF Downtime (Months)

Rent Abatement (Months)

Downtime + Abatement

RUL(Months)

Market Base Rent Per SF

(Monthly)

Total Rent(Monthly)

LostRent

(a) (b) (c) (d) = (b) + (c) (e) (f) (g) = (a) * (f) (h) = (d) * (g)

4 547 6 0 4 0 10 0 57 $ 1 88 $ 8 526 $ 85 2564,547 6.0 4.0 10.0 57 $ 1.88 $ 8,526 $ 85,256

Point of Debate- Present Value Factor of Lost Rent?

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Case Study (Office)


Tenant Improvement Allowance

(iv)(iv)

SF TI Allowance(PSF)

RUL(Months)

Market Terms(Months)

Remaining %Market Term Total TI's

(a) (b) (c) (d) (e) = (c) / (d) (f) = (a) * (b) * (e)

4 547 $ 2 00 57 60 95 0% $ 8 6394,547 $ 2.00 57 60 95.0% $ 8,639

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Case Study (Office)


Lease-In-Place Value (Total)

(i) (ii) (iii) (iv)(i) (ii) (iii) (iv)Total

Leasing CostTotal Reimbursement

RevenueLostRent Total TI's LIP

Value

(a) (b) (c) (d) (e) = (a) + (b) + (c) + (D)

$ 36 583 $ 84 50 $ 85 256 $ 8 639 $ 130 563$ 36,583 $ 84.50 $ 85,256 $ 8,639 $ 130,563

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Case Study (Office)

Step 9: Reconcile fair value estimates and allocate remaining (intangible) value, if any, to goodwill.

Fair Adjustment Fair ValueValue Factor Allocated

Net Purchase Consideration to be Allocated: $ 36,150,000 $ 36,150,000

As-Is 36,150,000 36,150,000 Variance 0.00%

Tangible Assets

As-Vacant 30,890,000 1.0112 31,240,000

Land 2,992,263 1.0112 3,030,000Land 2,992,263 1.0112 3,030,000 Building Improvements 26,418,467 1.0112 26,710,000 Site Improvements 227,668 1.0112 230,000

Total Tangible Assets 29,638,398 29,970,000

Intangible Assets

Leasehold (Building)Leasehold (Building)Total Advantage 810,354 1.0112 820,000 Total Disadvantage (248,265) 1.0112 (250,000)Total 562,089 570,000

In Place Lease 5,549,514 1.0112 5,610,000

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Total Intangible Assets 6,111,603 6,180,000

Total Assets Allocated $ 35,750,001 $ 36,150,000

Common Pitfalls and Mistakes

Portfolio Transactions

Occasionally appraisers will utilize the allocated purchase prices provided by the client for a portfolio and neglect to show support for the allocated purchase price.support for the allocated purchase price.

Why does it matter you ask?

If the client doesn’t use an appropriate methodology to allocate the purchase price, then the stated purchase price may be incorrect and the allocation may not reconcile.

A (real life) example of using the wrong methodology is utilizing the direct capitalization approach based on in-place net operating income for an unstabilized property to derive allocated purchase price

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allocated purchase price.


As Is and As-If-Vacant Calculations

Keep market leasing assumptions consistent with those utilized in the As Is calculation under Step 1.p

Do not assume demand based on existing demand; the scenario assumes the tenants are displaced so overall demandscenario assumes the tenants are displaced so overall demand would increase by the amount of space currently occupied.

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Replacement Cost New Less Depreciation (RCNLD)

Utilize the cost approach (RCNLD) to support the allocated building value; do not base allocation on a building residual.

Include (don’t exclude) soft costs (those excluded from MVS base costs) and developers profit in the RCNLD calculation. But how much?

Do not reconcile RCNLD (inclusive of land) to purchase price.

Include support for effective age and depreciation; older age may reflect deferred maintenance and younger age reflects renovations and capital improvements.

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IRC § 1060

Under Internal Revenue Code (IRC) § 1060, an applicable asset i iti i t f h th di t i di t facquisition is any transfer, whether direct or indirect, of a group

of assets if the assets transferred constitute a trade or business in the hands of either the seller or the purchaser and the purchaser’s basis in the transferred assets is determined whollypurchaser s basis in the transferred assets is determined wholly by reference to the purchaser’s consideration.

For purposes of determining the seller’s amount realized for each of the assets sold in an applicable asset acquisition theeach of the assets sold in an applicable asset acquisition, the seller allocates consideration to all the assets sold by using the residual method under §§ 1.338–6 and 1.338–7.

Under the residual method the market value is allocated to land Under the residual method the market value is allocated to land and building (i.e., Class V assets) and the intangible value attributed to the in-place-leases is allocated to building improvements

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improvements.

Take away…

When performing a purchase price allocation for tax reporting th i t ibl l i ll t d t b ildipurposes, the intangible value is allocated to building.

Using the same as example as before, the allocation for tax reporting purpose would be as follows:

Purchase Price Allocation

ASC 805 IRC § 1060

Purchase Price $ 36,150,000 $ 36,150,000

Land 3,030,000 Land 3,030,000 Building & Site Improvements 26,940,000 Building & Site Improvements 33,120,000 Building Advantage/Disadvantage 570,000 In Place Lease 5,610,000

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FASB 2014 An Appraiser's Guide To Purchase Price Allocation -Final

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