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SEC 4555 - Financial statements of acquired or to be acquired real estate operations
Publication date: 30 Jun 2023
us PwC SEC Volume 4555
[Editor’s note: In May 2020, the SEC adopted amendments to its disclosure requirements relating to acquired and to be acquired real estate operations. See SEC Release No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses (SEC Release 33-10786). The amendments became effective on January 1, 2021, subject to voluntary early compliance and the transition provisions described in Section II. F of SEC Release 33-10786. SEC 4555 contains guidance relating to acquired and to be acquired real estate operations under the amended rules.
The SEC staff has published extensive interpretive guidance relating to the acquisition of real estate operations (e.g., SEC FRM Section 2300). Much of the guidance was issued prior to the adoption of SEC Release 33-10786. Care should be exercised when considering guidance that was issued prior to the adoption of SEC Release 33-10786.]
.1 General
.11 In what circumstances does the SEC require the filing of financial statements relating to acquired or to be acquired real estate operations?
The SEC requires the filing of financial statements of acquired or to be acquired real estate operations in many situations. S-X 3-14 and S-X 8-06 (for smaller reporting companies) are the principal rules that govern these types of financial statements. However, S-X 3-14 and S-X 8-06 are not the only sources of disclosure requirements relating to acquired or to be acquired real estate operations. The instructions of the applicable registration or reporting form that is being prepared must be evaluated to determine whether financial statements or other disclosures relating to an acquired or to be acquired real estate operation are required. For example:
- if an issuer files a registration statement under either the Securities Act or the Exchange Act, the instructions to the specific registration form being used may require the filing of financial statements relating to an acquired or to be acquired real estate operation (e.g., Item 27 of Form S-11 and Item 13 of Form 10).
[Editor’s note: Some of the provisions of S-X 3-14 may not be applicable in a situation in which an offering or sale is being made pursuant to an already effective registration statement (i.e., the requirements may be different when applied in connection with a prospectus supplement as compared to a new or amended registration statement). See SEC 4550.2221.]
- if an SEC registrant that is required to file current reports on Form 8-K acquires a significant real estate operation, Item 9.01(a) of Form 8-K specifies the financial statements that are required in the Form 8-K and the timing (e.g., Item 9.01(a)(1) references S-X 3-14 for determining the financial statements that must be filed).
[Editor’s note: Certain aspects of S-X 3-14 are not applicable to filings made on Form 8-K. Specifically, financial statements of probable acquisitions of real estate operations are not required and the aggregation requirements described in Step 3 of SEC 4555.2 do not apply.]
- SEC forms used in connection with business combination transactions (e.g., Form S-4) oftentimes require financial statements of the target real estate operation (see, for example, Items 15-17 of Form S-4 and Item 14 of Schedule 14A, each of which specifies the financial statements of the target that are required, generally without direct reliance on S-X 3-14 or S-X 8-06 with respect to the target’s financial statements).
[Editor’s note: SEC 4555 is focused on the requirements applicable to a registrant that is not a smaller reporting company or a foreign private issuer. Other considerations may apply if a registrant is a smaller reporting company or a foreign private issuer.]
S-X 3-14 does not apply to the acquisition of a real estate operation that is a predecessor of the registrant. The financial statements of an acquired or to be acquired real estate operation that is determined to be the predecessor to its acquirer must be provided in the filings of the acquirer pursuant to S-X 3-01 and 3-02. See SEC FRM 2005.6. Guidance related to a predecessor’s reporting obligations can be found at SEC 4550.5.
.2 Applying S-X 3-14 in a registration statement or proxy statement
.21 How is S-X 3-14 applied in connection with a registration statement or proxy statement?
S-X 3-14 is generally applied in 3 distinct steps:
- Step 1: Determine whether a transaction has occurred or is probable that is within the scope of S-X 3-14. See SEC 4555.22.
- Step 2: Determine whether financial statements relating to the acquisition of an individual real estate operation (including the acquisition of a group of related real estate operations) are required. See SEC 4555.23.
- Step 3: Determine whether disclosures are required relating to aggregate significance of acquired or to be acquired real estate operations for which financial statements are not (or not yet) required. See SEC 4555.24.
.22 What factors are used to determine whether a transaction has occurred or is probable that is within the scope of S-X 3-14? (Step 1)
S-X 3-14 applies to real estate operation acquisitions:
- that occurred during the most recent fiscal year or subsequent interim period for which a balance sheet is required by S-X 3-01;
- that occurred after the date of the most recent balance sheet filed pursuant to S-X 3-01; or
- that are probable.
S-X 3-14 does not apply to a real estate operation which was totally held (as defined in S-X 1-02(y)) by the registrant prior to consummation of the transaction (S-X 3-14(a)(4)).
.221 How is the term “real estate operation” defined for purposes of applying S-X 3-14?
S-X 3-14(a)(2)(i) defines the term real estate operation as “a business (as set forth in S-X 11-01(d)) that generates substantially all of its revenues through the leasing of real property.” See SEC 4550.211 for a discussion of the definition of a business as set forth in S-X 11-01(d).
There is no bright line percentage for determining whether substantially all revenues are generated through the leasing of real property. The registrant should consider the specific facts and circumstances when making the evaluation.
[Editor’s note: Footnote 244 to SEC Release 33-10786 indicates that office, apartment, and industrial buildings, as well as shopping centers and malls, generally meet the definition of a real estate operation. Properties that generate revenues from operations other than leasing, such as nursing homes, hotels, motels, golf courses, auto dealerships, and equipment rental operations generally do not meet the definition of a real estate operation because these operations are more susceptible to variations in revenues and costs. See also Securities Act Forms CDI 113.03. The acquisition of a business that does not meet the definition of a real estate operation is evaluated under S-X 3-05. See SEC 4550.]
The definition of a real estate operation includes the acquisition of an interest in a real estate operation accounted for under the equity method or in lieu of the equity method, the fair value option. See S-X 3-14(a)(2)(ii).
.222 How is the term “probable” defined for purposes of applying S-X 3-14?
See SEC 4550.212 for a discussion of the term probable as it is used in S-X 3-14.
.223 When are real estate operations considered “related” for purposes of applying S-X 3-14?
Acquisitions of a group of related real estate operations that are probable or that have occurred subsequent to the latest fiscal year-end for which audited financial statements of the registrant have been filed are treated as if they were a single acquisition for purposes of determining significance under S-X 3-14. S-X 3-14(a)(3) states that acquisitions are related if:
- they are under common control or management;
- the acquisition of one real estate operation is conditional on the acquisition of each other real estate operation; or
- each acquisition is conditioned on a single common event (e.g. an IPO).
S-X 3-14 also states that the required financial statements of related real estate operations may be presented on a combined basis for any period that they are under common control or management. See S-X 3-14(a)(3).
.23 How do you determine whether financial statements relating to the acquisition of an individual real estate operation (including the acquisition of related real estate operations) are required? (Step 2)
Once a transaction has been determined to be within the scope of S-X 3-14 (i.e., the acquisition of a real estate operation has occurred within the relevant time period or is probable), the determination as to whether financial statements are required is generally dependent on two distinct considerations: significance and timing. (See SEC 4555.22)
[Editor’s note: If the evaluation is being made in connection with registering the offering of securities to the holders of the real estate operation being acquired, then the specific requirements of the registration form being used (e.g., Form S-4) should be evaluated to determine whether financial statements are required.]
.231 How is significance evaluated under S-X 3-14?
The significance evaluation under S-X 3-14 is performed using only the investment test in S-X 1-02(w)(1)(i) as modified by S-X 3-14(b).
If the investment test is 20% or less, then financial statements of the acquired or to be acquired real estate operation are not required based on individual significance. See S-X 3-14(b)(2)(i)(A).
If the investment test exceeds 20%, then financial statements of the acquired or to be acquired real estate operation for at least the most recent fiscal year (audited) and for the most recent interim period (unaudited) as specified in S-X 3-01 and 3-02 must be filed. See S-X 3-14(b)(2)(i)(B).
Financial statements of the real estate operation acquired or to be acquired must be filed for the periods specified above or such shorter period as the real estate operation has been in existence. See S-X 3-14(b)(2).
[Editor’s note: Under certain circumstances financial statements covering a period of 9 to 12 months will be deemed to satisfy a requirement for filing financial statements for a period of 1 year. See S-X 3-06.].
When the investment test is based on the total assets of the registrant and its subsidiaries consolidated (e.g., when the registrant has no aggregate worldwide market value as described in S-X 1-02(w)(1)(i)(A)), the “investments in and advances to” the tested real estate operation (i.e., the numerator of the investment test) is modified to include any assumed debt secured by the real estate property. See S-X 3-14(b)(2)(ii).
[Editor’s note: Examples of when the registrant would not have an aggregate worldwide market value include during an initial public offering or when the registrant’s stock is not publicly traded.]
For example, assume that on June 2, 2023 Company Y, a calendar year-end company in the initial public offering process, acquired Property P, a calendar year-end business that meets the definition of a real estate operation. Company Y paid $10 million to Property P’s owner and assumed $8 million of debt secured by Property P. Further assume that Company Y had total assets of $85 million as of December 31, 2022.
Given that Company Y does not have an aggregate worldwide market value, it would be required to include any assumed debt secured by Property P in its “investments in and advances to” calculation for purposes of assessing significance under S-X 3-14(b):
Assumed debt secured by Property P |
8 million |
||
Based on these facts, the modified investment test yields a level of significance above 20% ($18 million / $85 million). Accordingly, audited financial statements of Property P as of and for the year ended December 31, 2022 and unaudited interim financial statements as of and for the three-month period ended March 31, 2023 would be required in the registration statement.
The significance determination must be made using the guidance in S-X 11-01(b)(3) and (4). S-X 11-01(b)(3) specifies the financial statements to be used for purposes of determining significance in situations other than those relating to a continuous offering conducted over an extended period of time in which the registrant applies the Item 20.D Undertakings of Industry Guide 5 - Preparation of Registration Statements Relating to Interests in Real Estate Limited Partnerships (Industry Guide 5). S-X 11-01(b)(4) applies in connection with a continuous offering conducted over an extended period of time in which the registrant applies the Item 20.D Undertakings of Industry Guide 5. See SEC 4555.6 for more information regarding the Item 20.D Undertakings of Industry Guide 5.
.232 Under what circumstances are financial statements of an acquired or to be acquired real estate operation that is greater than 20% significant not required in a registration statement or proxy statement?
S-X 3-14(b)(3) provides circumstances under which a registration statement that is not subject to Securities Act Rule 419 (regarding offerings by blank check companies) or a proxy statement is not required to include the financial statements of a greater than 20% significant acquired or to be acquired real estate operation based on individual significance. These circumstances are similar to those described for an acquired or to be acquired business under S-X 3-05(b)(4)(i) as discussed in SEC 4550.222.
Additionally, see SEC 4550.2221 for a discussion of financial statement requirements in an already effective registration statement.
.233 Would pre-acquisition financial statements be required once an acquired real estate operation has been included in the registrant’s audited consolidated financial statements for at least nine months?
Registrants may omit separate financial statements of an acquired real estate operation from a registration statement or proxy statement once the results of operations of the acquired real estate operation have been reflected in the registrant’s audited consolidated financial statements for at least nine months. See S-X 3-14(b)(3)(iii).
.24 How do you determine whether disclosures are required relating to aggregate significance of acquired and to be acquired real estate operations for which financial statements are not (or not yet) required? (Step 3)
In addition to considering the significance of acquired and to be acquired real estate operations on an individual basis, S-X 3-14(b)(2)(i)(C) requires consideration of the aggregate significance of real estate operations acquired or to be acquired since the date of the most recent audited balance sheet filed for the registrant, for which financial statements are either:
- not required because the acquired or to be acquired real estate operation is not significant above the 20% level or
- not yet required based on the timing guidance referred to in SEC 4555.222.
Aggregate significance is calculated as the sum of the investment tests for the individual acquired or to be acquired real estate operations. If the sum of the investment tests for the individual acquired or to be acquired real estate operations exceeds 50%, then the aggregate investment test has been met and the disclosures described below are required.
[Editor’s note: The guidance above relates to S-X 3-14. S-X 3-05(b)(2)(iv) requires a similar evaluation with respect to the aggregate impact of businesses acquired and to be acquired. Under S-X 3-05(b)(2)(iv), the aggregate investment test also includes the results of the aggregate investment test of any acquired or to be acquired real estate operations under S-X 3-14(b)(2)(i)(C). See SEC 4550.23.]
.241 What disclosures are required relating to aggregate significance?
If the aggregate investment test condition described in S-X 3-14(b)(2)(i)(C) exceeds 50%, the following disclosures are required:
- financial statements covering at least the most recent fiscal year and the most recent interim period specified in S-X 3-01 and 3-02 that are not yet required based on the guidance referred to in SEC 4555.223; and
- pro forma financial information pursuant to S-X 11-01 and 11-02 that depicts the aggregate impact of all acquired and to be acquired real estate operations in all material respects.
[Editor’s note: The financial statement requirements under the aggregate significance assessment are limited to acquired or to be acquired real estate operations that are significant above 20% individually (acquisitions of related real estate operations would be evaluated as a single acquisition). However, the pro forma financial information is required to depict the aggregate impact of all the acquired or to be acquired real estate operations (in all material respects) without regard to whether their historical financial statements are required to be provided.]
.242 How is the age of S-X 3-14 financial statements determined?
The age of financial statement requirements under S-X 3-14 are applied the same way they are applied under S-X 3-05. See SEC 4550.4.
.25 What are the financial statement presentation requirements under S-X 3-14?
The financial statement presentation requirements applicable to acquired or to be acquired real estate operations are set forth under S-X 3-14(c). The financial statements may be only statements of revenues and expenses excluding expenses not comparable to the proposed future operations such as mortgage interest, leasehold rental, depreciation, amortization, corporate overhead and income taxes. The notes to the financial statements must include the following disclosures specified by S-X 3-14(c)(2):
- the type of omitted expenses and the reason(s) why they are excluded from the financial statements;
- a description of how the financial statements presented are not indicative of the results of operations of the acquired real estate operation going forward because of the omitted expenses; and
- information about the real estate operation's operating, investing and financing cash flows, to the extent available.
.26 What supplemental information is required by S-X 3-14?
S-X 3-14(f) requires the following supplemental information to be filed with the financial statements for each real estate operation:
- material factors considered in assessing the real estate operation, including sources of revenues (including, but not limited to, competition in the rental market, comparative rents, and occupancy rates) and expenses (including, but not limited to, utility rates, property tax rates, maintenance expenses, and capital improvements anticipated); and
- other material factors that would cause the reported financial statements not to be indicative of future results.
[Editor’s note: S-X 3-14(f) indicates that the factors considered by the registrant “must be described in the filing”. S-X 3-14(f) does not specifically require the inclusion of the supplemental information in the financial statements. When these financial statements are presented in Form S-11, the above discussion should supplement the “Operating Data” disclosures required by Item 15 of Form S-11.]
.27 Can S-X 3-14 financial statements relating to foreign real estate operations be prepared using local GAAP or IFRS?
The financial statements of an acquired or to be acquired real estate operation that meets the definition of a foreign businesses (as set forth in S-X 1-02(I)) may be presented in accordance with S-X 3-14(d).
The financial statements of an acquired or to be acquired real estate operation that do not meet the definition of a foreign business but would qualify as a foreign private issuer (as defined in Securities Act Rule 405 and Exchange Act Rule 3b-4) may be presented in accordance with S-X 3-14(e).
.3 Pro forma financial information
The pro forma financial information described in S-X Article 11 generally must accompany financial statements of a significant acquired or to be acquired real estate operation. If a registrant presents the financial statements of an individually insignificant real estate operation, the SEC staff encourages the registrant to also provide S-X Article 11 pro forma financial information in the filing (see SEC FRM 3110.3). If pro forma information is required by S-X Article 11, it should generally be filed at the same time the audited financial statements of the acquired or to be acquired real estate operations are filed.
See SEC 4560 for a discussion of pro forma financial information.
.4 Properties subject to triple net leases
A triple net lease typically requires the lessee to pay costs normally associated with ownership of the property, such as property taxes, insurance, utilities, and maintenance costs. When a registrant has triple net leased one or more real estate properties to a single lessee/tenant, and such properties represent a “significant” portion of the registrant’s assets, a registrant should consider the need to provide the lessee’s financial statements or other financial information. An asset concentration is generally considered “significant” if it exceeds 20% of the registrant’s assets as of its most recent balance sheet. See SEC FRM 2340.
[Editor’s note: SEC Release 33-10786 clarifies that the requirements of S-X 3-14 also apply to triple net leases because the activity depicted in the S-X 3-14 financial statements is consistent with how the triple net lease arrangement may affect the registrant’s results of operations. See footnote 219 to SEC Release 33-10786. Accordingly, financial statements of a lessee or guarantor in a triple net lease arrangement cannot be provided in lieu of any required S-X 3-14 financial statements.]
.5 Properties securing mortgage loans
Included in the category of properties acquired or to be acquired under S-X 3-14 are operating properties underlying certain mortgage loans, which in economic substance represent an investment in real estate or a joint venture rather than a loan. The financial statements of properties which will secure mortgage loans made or to be made which have the characteristics of real estate investments or joint ventures may be required by S-X 3-14. SAB Topic 1-I sets forth SEC staff guidance regarding properties securing mortgage loans.
.6 Blind pool real estate offerings
Certain registrants, typically non-traded real estate investment trusts, that sell securities in continuous offerings over an extended period of time follow the disclosure guidance in Industry Guide 5. Industry Guide 5 provides different Securities Act and Exchange Act reporting requirements with respect to the acquisition of real estate operations both during and after the distribution period. See SEC FRM 2325.
[Editor’s note: The distribution period (as defined in the Note to SEC FRM 2325.1) is the period during which the registrant is conducting a continuous Securities Act registered offering through a registration statement subject to Industry Guide 5. We understand that the SEC staff does not consider a registration statement filed prior to effectiveness to be made during the “distribution period”. We understand that the significance test calculations under S-X 1-02(w) should be used to calculate the significance of any properties acquired before the distribution period. See SEC 4400.]
Registrants in these types of offerings generally do not initially identify the specific assets that will be acquired with the proceeds of the offering. Rather, the offering materials generally include a description of the types and ranges of assets that will be acquired. These types of offerings are oftentimes referred to as blind pool offerings.
Registrants raising capital through blind pool real estate offerings undertake to disclose information about significant acquisitions in addition to financial statements under S-X 3-14. The undertakings include the use of sticker supplements related to certain significant real estate operations that will be acquired and post-effective amendments.
As noted above, S-X 3-14(b)(2)(iii) provides that the significance determination with respect to a real estate operation is made using S-X 11-01(b)(3) and (4). S-X 11-01(b)(4) provides guidance for performing the investment test when a registrant, including a real estate investment trust, conducts a continuous offering over an extended period of time, applies the Item 20.D. Undertakings of Industry Guide 5, and bases the investment test on the total assets of the registrant and its subsidiaries consolidated.
[Editor’s note: S-X 11-01(b)(4) also applies to non-real estate business acquisitions by registrants in blind pool offerings. A registrant conducting a blind pool offering could be required to provide financial statements relating to real estate operations under S-X 3-14 and financial statements relating to businesses under S-X 3-05.]
When the S-X 3-14 investment test is performed under S-X 11-01(b)(4), the numerator of the significance test is calculated as described in S-X 3-14(b)(2)(ii). See example in SEC 4555.231.
The calculation of the denominator of the significance test will depend on whether the calculation is performed (i) during the distribution period, (ii) after the distribution period has ended but before the next Form 10-K is filed, or (iii) after the next Form 10-K is filed. See S-X 11-01(b)(4)(i)-(iii).
[Editor’s note: The denominator calculated under S-X 11-01(b)(4)(i) includes, in addition to the total assets of the registrant as of the date of acquisition or disposition, the registrant’s good faith estimate of offering proceeds (net of commissions) to be raised in the registered offering over the next 12 months. When estimating the offering proceeds expected to be raised in the registered offering over the next 12 months, the registrant could consider the pace of fundraising as of the measurement date, the sponsor or dealer-manager’s prior public fundraising experience, and offerings by similar companies. See footnote 275 to SEC Release 33-10786.]
For further information about the disclosure requirements for undertakings see Item 20.D. of Industry Guide 5, Disclosure Guidance: Topic No. 6 – Staff Observations Regarding Disclosures of Non-Traded Real Estate Investment Trusts and SEC FRM 2325.2.
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