COVID-19 challenges in commercial real estate audits

GettyImages-468759872Now that 2020 has concluded, many owners of commercial real estate are contending with the coronavirus pandemic’s impacts on their financial performance.

As auditors, you should recognize that the execution of financial statement audits for 2020 is going to be different from prior years, and the commercial real estate market brings with it a range of issues that you will have to be prepared for. You can expect many facets of a commercial real estate audit to feel the pandemic’s effects. The focus of this blog is on impairment considerations for commercial real estate properties.

You and your engagement team may want to make use of AICPA resources such as the COVID-19 audit toolkit and the COVID-19 accounting resources.

The pandemic’s economic impact has varied among property types with the most acute being seen initially in portions of the retail and hospitality sectors, where operations were negatively affected by mandates that required temporary closure or limitations on operations in response to the COVID-19 pandemic. Regardless of the property type, however, as you prepare for audits of year-end financials, you should evaluate whether the pandemic has affected impairment considerations. 

  1. Forecasts

Given the current economic environment, impairment considerations of commercial real estate generally warrant careful considerations. Forecasts, particularly cash flow forecasts about clients’ future financial performance, may play a key role in impairment assessments, and auditors may need to evaluate the reasonableness of these forecasts.

When estimating undiscounted cash flows as part of an impairment recoverability test performed in accordance with FASB ASC 360, Property, Plant, and Equipment, the forecasts of lease income over a property owner’s expected holding period play an important role. You may need to compare the cash flow forecasts to the contractual rent obligations. You may also need to assess the reasonableness of assumptions about the collectability of rent payments and tenants’ readiness to renew their leases.

For example, in certain sectors, property owners have granted rent holidays to certain struggling lessees. In such scenarios, lessors are expecting tenants to resume making rent payments when the impacts of COVID-19 are no longer negatively affecting operations. Clients’ assessments of the collectability of deferred lease payments and the risks that property owners face as they try to re-establish tenants on a predictable payment plan should be evaluated when considering their cash flow forecasts. This analysis may include consideration of the tenants’ creditworthiness and the impact the COVID-19 pandemic has had on operations.

  1. Valuations

You may also need to consider property valuations as part of impairment assessment. This year, the valuation process may be more difficult because of the absence of a steady flow of property sales. Some segments of the real estate market, such as industrial property, remain active. But in segments such as retail, prospective buyers may be counting on discounts that property owners are unwilling to offer.

The forecasting and valuation challenges are most pronounced in assessments of key valuation assumptions, which often include the work of third-party specialists, such as property appraisers, that management may use to assist with valuations.[1] You should typically request documentation that supports the appraisers’ estimates and make sure you understand the factors that contributed to the estimates and forecasts.

If, as part of the impairment test, it is necessary to determine the fair value of the property in accordance with FASB ASC 820, Fair Value Measurement, you should request documentation about the market assumptions used in arriving at the forecasts.

The lack of reliable data about property sales limits the amount of information available when assessing a property’s value. You should be well prepared for your discussions with appraisers and valuation preparers. You may have to challenge estimates that do not appear reasonable and make sure you understand the valuation methodology and assumptions.

  1. Importance of judgment

Uncertainty around property valuations adds to the discipline necessary in the use of professional judgment for 2020 audits.

Because each real estate market is distinct, and each property has its specific characteristics, you need to pay close attention to the facts and circumstances for each property.

Moreover, the longer the COVID-19 pandemic affects operations, forecasting expectations becomes harder. During previous economic downturns, business owners that survived were frequently required to sharpen their skills at managing how the crisis affected their finances.

The coronavirus pandemic is different. Its impact has already lasted for a year, and it’s far from certain when it will end. The economic fallout is becoming more severe and somewhat less predictable. The pandemic’s changing severity has added to the difficulty of making a wide range of estimates. It’s not clear what the economy that emerges in 2021 or 2022 will look like. Audit work will need to contemplate this new reality.

John Solomon, MAI, Deloitte Risk & Financial Advisory Managing Director, Deloitte Transactions and Business Analytics LLP. John is a leader in Deloitte Risk & Financial Advisory’s real estate consulting practice. John has over 25 years of experience advising organizations in all industries on commercial real estate matters inclusive of valuation, M&A, lease analysis, tax and financial reporting, financial modeling and public-private partnerships.

Eric Knachel, CPA, senior consultation partner, Professional Practice Group, Deloitte & Touche LLP. Eric is a senior consultation partner in the Professional Practice Group at Deloitte & Touche LLP with more than 25 years of experience. He leads Deloitte’s revenue recognition subject-matter team and guides audit practitioners and companies on complex financial accounting and reporting issues involving revenue recognition. Eric holds a bachelor’s degree in accounting from the University of Maryland. He is a CPA and a member of the American Institute of Certified Public Accountants.


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[1] Regardless of whether valuations are performed by management or a third party, management is responsible for the estimates that are used to prepare the financial statements and for underlying assumptions used in developing these estimates.