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A Comprehensive Guide to GAAP for Commercial Real Estate

Written by Gene Godick | April, 29, 2024

 

A Comprehensive Guide to Generally Accepted Accounting Principles for Commercial Real Estate 

Generally Accepted Accounting Principles (GAAP) set the framework for financial reporting in the US. Adopting GAAP enables organizations to build a transparent and accurate view of their financial health.  

GAAP compliance is important not only for streamlining internal financial processes but also for decision-making, investor confidence, and even securing debt and equity financing.  

However, within the CRE industry, many firms prioritize tax-focused accounting (cash basis) to secure tax advantages. Unfortunately, this approach can present a limited and potentially misleading picture of a firm’s finances. That’s where taking a more sophisticated approach to accounting and finance, including adopting GAAP, becomes especially important.  

G-Squared Partners serves as a strategic financial advisor to a wide variety of CRE investors and operators. We provide a sophisticated suite of outsourced CFO, accounting, and bookkeeping services to the CRE community. Contact us today to learn more about how we can support your CRE business. 

Why CRE Funds and Operators Need to Adopt GAAP 

So, why should CRE funds and operators take GAAP seriously? First, it’s an essential component that powers strategic decision-making. Using this more advanced approach to financial management reveals cash flow patterns and overall financial well-being, all of which help your team make better decisions. 

Some CRE investors and many lenders require CRE funds to adopt GAAP. GAAP-compliant financial statements are often a prerequisite for funds looking to secure external financing. These financial statements present a standardized snapshot of a firm’s health, making it easier for readers of the financial statement to compare different opportunities and ensure the information presented is reliable.  

Lastly, relative to purely cash-basis accounting, which reflects cash in and out, GAAP’s use of accrual-based accounting helps leaders uncover emerging financial problems that could jeopardize the organization’s stability.  

Here’s one simple example. Using accrual-based accounting ensures that property taxes, even if the bill hasn't arrived yet, are factored into accounting reports. This can prevent sizable tax bills from going unnoticed until the time to pay arrives.  

Key GAAP Components for CRE Operators 

What are the key elements of GAAP that CRE operators need to understand? It all starts with accurate financial statements. Financial reporting is the cornerstone of GAAP compliance. CRE firms should produce the following financial statements on a regular basis: 

    • Income Statement: accurate income statements show profitability over a period while tracking key performance indicators including revenue, expenses, and net income. 
    • Balance Sheet: a balance sheet offers a snapshot of a firm’s assets, liabilities, and equity. 
    • Cash Flow Statements: cash flow statements display how cash flows in and out of the business: patterns that are crucial to the day-to-day management of any CRE business.  

Another key component of GAAP to understand is lease accounting. GAAP lease accounting standards (such as ASC 842) ensure that leases are reflected accurately on balance sheets. There is a difference between operating and finance leases, as this impacts how a lease is reflected as an asset and obligation. Nevertheless, GAAP demands accurate calculations of lease liabilities and right-of-use assets, influencing financial metrics. 

Of course, there are many things to keep in mind when approaching GAAP compliance. Here are a few more considerations to keep in mind in terms of GAAP standards: 

    • Accrual Accounting: we touched on this earlier, but remember that revenue is recognized when earned, not necessarily when funds are received. In addition, expenses are recognized when incurred or when the service is provided, not when the bill is paid. 
    • Depreciation: under GAAP, the majority of assts are depreciated on a straight-line basis. However, other methods can be used that provide tax advantages, but these should only be used for tax reporting, not financial reporting.  
    • Asset Valuation: Under GAAP, companies are required to review long-term assets for possible impairment annually. For example, if a CRE fund owned an office building and could only find new tenants at significantly lower rents, it may have to record an impairment charge in its earnings that reflected a lower asset value of the building.  

Common Errors CRE Firms Make with Their Financials 

GAAP is complex, but, in the end, it’s a critical component of financial health and overall operational efficiency. Of course, ensuring that your firm remains GAAP-compliant requires a commitment to consistency paired with proven accounting acumen. It’s just a reality that some CRE firms get it wrong. To help you and your team better understand what mistakes look like in GAAP compliance, here are a few common issues that a CRE firm might face. 

The first is simply not accruing expenses. If a bill arrives in March for work done in February, cash accounting would book it as a March expense, while GAAP would require it to be recorded as a February expense.  

There are also revenue recognition issues to consider. If a CRE firm logs rent only when payment arrives, it can present inaccuracies in reporting. GAAP requires revenue to be recognized as it is earned under the lease, regardless of when the check arrives. This affects both revenue and potential issues with delinquent tenants. 

While larger firms usually have a handle on GAAP, it’s smaller CRE firms who might manage their financials themselves and lack accounting knowledge that can fall for these common errors. Understanding the intricacies of GAAP requires training. Outsourcing to accounting professionals can not only save money in the long run but also prevent financial mistakes, all while maintaining strict compliance.  

Reconciling GAAP and Tax Treatment Differences 

Understanding book-to-tax adjustments is essential when it comes to GAAP and taxes. While GAAP-compliant financial statements give CRE firms a standardized view of financial health, the goal of tax accounting is to minimize taxable income. As a result, book-to-tax reconciliation is necessary. Tax advisors play an important role in this process. 

While these can seem like separate approaches, CRE firms should understand the benefits of a dual perspective. GAAP brings in an accurate picture of a firm’s financial position for strategic internal decision-making, operational matters, and investor confidence. The role of tax accounting, on the other hand, is to ensure the firm’s financials are managed in a tax-efficient manner that leverages the wide range of tax planning opportunities available to CRE investors.  

G-Squared Partners: Experts in CRE GAAP Compliance 

Switching from a purely cash-focused perspective on accounting to a GAAP-centered approach can be challenging, but the long-term benefits for your CRE firm are undeniable. Whether it’s improved decision-making, stronger investor relationships, or proactive risk management, embracing GAAP compliance in your financial operations is a critical element of staying fiscally fit in the world of CRE.  

Here at G-Squared Partners, we’re experts in the nuances of CRE accounting, providing a variety of financial services like outsourced accounting or higher-level financial guidance through an outsourced CFO. Our experienced team specializes in CRE and can seamlessly integrate with your firm to ensure GAAP standards are upheld. 

If you’re ready to unlock the true potential of your CRE firm by streamlining your financial operations, contact our team today.