Pre 1970: Before Blake and PRISA

1
Pre 1970 Before Blake and PRISA
REIS History

• SEC formed as a result of Great Depression -
  Beginning of Regulation
• 1933-34 Acts regulate operating companies
• Investment Advisers Act of 1940 regulate
  investment advisory business
• Parallels to today Can you say Enron/WorldCom

1930s
Real estate investing principally done by wealthy
individuals, corporations and mutual insurance
companies
Investment Performance Measurement begins modern
era with introduction of BAI formula
1960s
2
1970s Institutional Real Investment, The Early
Years
Investment/Real Estate
Performance/Valuation
Accounting
Prudential creates PRISA Response to growing
interest by investors in propertiesOpen-end,
core commingled fund
Blake Eagle joins Russell First R.E. Consultant
Coldwell Banker creates first Closed-end
Commingled Real Estate Fund REIT Boom/BustHighly
Levered, Externally advised Mortgage REITS
FASB CreatedSuccessor to Acct Principles
BoardFull time independentSelf
regulatingFormally recognized by SEC as
authoritative
ERISA Prudent Person InvestingTitle 1 Fair
Value Reporting
RREEF America First Closed End R.E. fund
NCREIF first Conceived
Prudential begins regular valuation of PRISA as
fund grows
PREA Established To lobby for Related Party
exemption for R.E. from DOL Separate Accounts
Begin
3
1980s From Boom to Bust
Investment/Real Estate
Performance/Valuation
Accounting/Regulation
High Inflation (1979-81)R.E. as Inflation
Hedge ERTA Accelerated DepreciationAcceleration
of R.E. Syndication
Syndication boom spawns tax induced investment
NCREIF Formed (6/17/82)3 Committees Accounting,
Research, Valuation NCREIF Research Committee
derives performance formula from BAI formula
NCREIF Accounting Committee develops guidelines
for market value accounting in R.E.
PrinciplesInvestors required market value based
information (ERISA)Accounting guidance was
unclear /non-existent mixed practices
4
Accounting Committee Through the 1980s

• Mission Investors required market value based
  information
• Who we were
• Senior decision makers currently working in fast
  paced, entrepreneurial investment advisory firms
• CPAs with public accounting experience
• The firms we represented
• Generally viewed themselves as long term holders,
  operators and hands-on managers of real estate
• Value creators rather than cash distributors
• Had no ownership interest in the vehicles
• Earned fees based on property values
• Not tied to performance
• Incentives were to buy more and hold longer
• What we knew
• Mixed accounting practices were prevalent
• Accounting guidance was not clear/non existent
• We wanted to understand differences and work
  towards establishment of best practices and
  narrow the practice
• Information we could rely upon
• Historical cost (accrual) basis of accounting was
  used by other real estate companies
• Investment Company Accounting supported current
  value

5
Accounting Committee Through the 1980s

• What we accomplished
• Summarized accounting and reporting practices
  used by institutional real estate investment
  industry
• Market value based financial statements should be
  rooted in historical cost (accrual) accounting
  model
• Provided operating results to investors
• Market value based financial statements should
  match appraisal methodology
• Assumes revenues are collected and expenses paid
  when billed
• Straight-lining rents prohibited
• Capital items are not a part of NOI
• Value increases or decreases reported were based
  on appraisal process
• GAAP depreciation not recognized
• Middle Paragraph opinions became expected and
  accepted as norm
• Primary financial statements were presented at
  fair value
• Middle paragraph indicated that appraisals
  contained estimates and assumptions which could
  not be subject to auditing standards
• Reported performance information calculated from
  audited financial results to clients, consultants
  and others
• Wheres the cash?
• Narrowed the Practice

6
1980s From Boom to Bust
Investment/Real Estate
Performance/Valuation
Accounting/Regulation
High Inflation (1979-81)R.E. as Inflation
Hedge ERTA Accelerated DepreciationAcceleration
of R.E. Syndication
Syndication boom spawns tax induced investment
NCREIF Formed (6/17/82)3 Committees Accounting,
Research, Valuation NCREIF Research Committee
derives performance formula from BAI formula
NCREIF Accounting Committee develops guidelines
for market value accounting in R.E.
PrinciplesInvestors required market value based
information (ERISA)Accounting guidance was
unclear /non-existent mixed practices
Tax ReformEliminates Accelerated depreciation
and establishes passive loss limits Level Playing
Field for Tax Exempts leads to boom 55 BN to
120 BN in five years
Mutual Funds advertise selective results to raise
capital SEC objects
Inquiries precipitate AIMR preparation of
Performance Presentation Standards FIRREA RTC
Regulation 41-B addresses minimal appraisal
standards
SL Industry starts to collapse FIRREA
EnactedRTC established
The First Institutional Real Estate Boom 6 cap
rates
7
1990s The Great Fall and Taking Stock
Real Estate CollapsesMarket turns illiquid RTC
commences loan auctions Time to take stock and
reassess
Merger of Appraisal Institute and Society of Real
Estate Appraisers Residential Appraisers
dominate Pru Valuation Investigation What is a
nearly empty Hilton worth
Investors question alignment of interests Birth
of the Opportunity fund with manager coinvestment
and incentive compensation
NCREIF forms Performance Measurement
Committee AIMR publishes Performance
Presentation Standards
NAREIM, PREA, and NCREIF join forces to create
REIS Self regulation activity in response to
severe investor criticism
NOI vs Cash debate continues Research raises
concerns about comparability with other asset
classes
NCREIF Market Value Accounting Policy Manual
published codification of 1980s model Deloitte
engaged to draft REIS First Standards published
in 1995
NCREIF Performance Measurement Committee provides
real estate examples for AIMR PPS
In absence of formal Market Value Accounting
Guidance in GAAP, REIS/NCREIF becomes Generally
Accepted Accounting Practice
DotCom Boom Why invest in Real Estate to earn
20 when I can double my money in a year?
8
Accounting Committee Through the 1990s

• Market Value Accounting Policy Manual Written
• Published in 1994
• Key Elements of Market Value Accounting Policy
  Manual
• Incorporated practices first analyzed and
  utilized in 1980s
• Recommended application of equity method of
  accounting
• Recommended consolidation accounting for
  investees
• Incorporated into REIS in 1995
• Authoritative accounting guidance within GAAP
  continued to not be available
• Market Value Accounting Policy Manual represented
  prevalent accounting practices in the industry
• Became GAAP, but lowest level in GAAP hierarchy
• Audit opinions moved descriptions of appraisal
  risk out of opinion and into footnotes

9
2000s To Go Where Real Estate Has Never Been
NASDAQ 5000 NASDAQ 1200Boom turns to Bust Real
Estate largely unscathed by scandals becomes
favored investment class as stocks tumble
AIMR-PPS becomes U.S. Global Investment
Performance Standards
Scandals Enron and WorldComBad
accounting/Numerous restatements
requiredEarnings managementSystem of checks and
balances doesnt work
REIS 2003 incorporates anticipated GIPS, which
isnt reality until 2005, but NCREIF team gets it
right
Plan for authoritative guidance re applicability
of Investment Company Audit Guide
commences Sarbanes-Oxley (2002)Response to
corporate scandalMore monitoring and rulesFASB
strengthened AICPA stripped of its power by the
FASB
Capital pours into real estate, driving values
dramatically higher REITs as the new hot dot
NCREIF licenses CSFB to offer derivatives off the
NPI
Real Estate Chapter of GIPS (2005) supported by
NCREIF Performance Measurement Committee Performan
ce Measurement focusing energies toward investor
reporting and asset level analytics
NCREIF grants derivative licenses to four
principal dealers.
Valuation moving beyond free and clear property
valuations to accommodate structured transactions
and entity level investments
10
Accounting Committee and REIS through the 2000s

• Recognized need for clarification of scope of
  Audit Guide for Investment Companies as it
  applied to real estate
• Higher level GAAP than current industry practice
• Presentation by NCREIF to AcSec on Scope Project
  (3/2004)
• Clarification of definition of real estate
  investment income
• SOP effective for fiscal years beginning on or
  after 12/15/07
• Likely effective date but may change
• Likely a significant portion of industry will
  require compliance
• REIS will change, but NAV will not!
• Major differences with current REIS
• Income based on dividend model vs. operating
  model
• No consolidation or equity method accounting is
  allowed
• Appreciation includes undistributed earnings
• Definition of Fair Value as defined in Fair Value
  Measurement Statement incorporated into REIS
• Supported Fair Value Option exposure draft
• Option to report notes payable liabilities at
  market value
• Will be effective concurrently with SOP
• REIS will require election of Fair Value Option
  in order to be REIS compliant
• NCREIF Survey and Guidance Development (2007)
• New standards and best practices