Whether the issue is revenue recognition, measurement, fair value, or impairment, the real estate industry has some very unique and complex accounting and financial reporting challenges. So if you advise or work for companies with real estate holdings, this course is for you. Learn how to properly record the purchase, sale, rental, or development of your real estate holdings.
Objectives:Prerequisite: Basic knowledge of real estate accounting.
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Real Estate Markets
Economists describe a real estate market as one of "monopolistic competition" because it combines elements of a monopoly with those of a purely competitive market. In a purely competitive market the goods are relatively homogeneous, divisible into small groups, and easily transportable. Barriers to entering the market are low. Many buyers and sellers exist, with no single one able to influence price.
Each market participant has complete knowledge about the product and is in general agreement about expectations about how the product will perform.
Characteristics of a Real Estate Market
Real estate markets do not have all of the characteristics of a purely competitive market. For example,
• A real estate asset is generally unique.
• Real estate assets occupy a fixed space and cannot be transported.
• Large owners or buyers have the ability to affect market price.
• Buyers and sellers of real estate often differ in their expectations of how the asset will perform or be used.
Although a given real estate asset enjoys certain monopolistic advantages (for example, location), similar assets offer close, though not perfect, substitutes. A premium will be paid for the monopolistic advantage, but only to the extent of the advantage perceived by the buyer.
The Laws of Supply and Demand
Within a given market, the prices of real estate assets are influenced by supply and demand. Of course, as with other markets, there is interdependence between the supply of real estate and the demand for real estate. When supply is greater than demand, development slows until the excess is absorbed and vice versa.
It is a bit of a "chicken and egg" problem to distinguish between a factor that drives supply and one that drives demand, but the following analysis should at least help you understand some of the supply and demand considerations.
Demand Factors
Factors that affect the demand for real estate include
• Mortgage interest rates.
• General economic conditions.
• Demographic changes and societal trends.
Mortgage Interest Rates
Because of the size of the debt financing for most real estate acquisitions, the level of mortgage interest rates affects the affordability of real estate assets. When interest rates fall, real estate becomes more affordable, and more buyers are encouraged to enter the market.
General Economic Conditions
General economic conditions affect businesses and their need for space. During expansionary times, if businesses grow, their need for office or warehouse space also will grow. Conversely, during a general recession, if businesses shrink, their need for space also will shrink. General economic conditions also impact wages and levels of individual income, which in turn affect the demand for housing. Mere perceptions of general economic conditions also can affect the demand for real estate. For example, perceptions among homeowners that the economy is strong or improving may lead to increased demand for housing.
Demographic Changes and Societal Trends
Trends toward corporate downsizing or telecommuting may affect the need for commercial space. The twentieth-century shift of the U.S. population from rural to urban to suburban altered the demand for housing in locations affected by the shift. The shift of the population in the early part of the 21st century will also impact real estate.
Supply Factors
Factors that affect the supply of real estate include
• Cost and availability of financing.
• Expected future demand.
• Changes in public policy.
Cost and Availability of Financing
When financing is not available or is available only at a high cost, real estate development will slow. As pointed out earlier, the converse also is true.
Expected Future Demand
When developers anticipate future demand for a product, they will develop that product. When they are pessimistic about future demand, they will decrease their level of development activities.
Changes in Public Policy
As described below, the federal, state, and local governments each play a significant role in the real estate industry.Changes in public policy (for example, changes in zoning or building codes) may affect the supply of real estate projects.
The Role of Government
Federal, state, and local governments each play an important role in the real estate industry and market. Governmental factors affecting real estate include
• Tax laws.
• Property taxes.
• Zoning.
• Building codes.
• Department of Housing and Urban Development (HUD) laws.
• Environmental regulations.
Tax Laws
Tax laws are one means used to implement public policy regarding the investment in or development of real estate. For example, tax law changes have been used to expand or contract the flow of funds to the industry.
The use of tax-advantaged entities (for example, real estate investment trusts, or REITs) is common in the real estate industry. The continued qualification of these entities for special tax treatment is a significant concern that should be addressed by auditors.
Property Taxes
The federal government is prohibited by the Constitution from levying a property tax; property tax is levied at the local level. The amount of the tax is calculated as a percentage of the property's value.
Zoning
The local government is responsible for zoning, which involves designating areas for various types of land use. Within a given zone, regulations might restrict property usage, such as the ways in which a building might be used, the percentage of land allowed to be covered by buildings, or the maximum height of a building. Zoning will impact development.
Building Codes
Building codes regulate the development and construction to help ensure safety, facilitate fire prevention, and provide adequate sanitation. For example, the thickness and height of walls and spacing of beams usually are regulated, as are the plumbing, electrical, and ventilation specifications. Cost of development may be affected by building code requirements.
Department of Housing and Urban Development (HUD) Laws
HUD is a federal agency that regulates the development and operation of all housing projects for which it insures mortgages or provides rent subsidies. These regulations include the requirement that audits of these entities be performed in accordance with the Consolidated Audit Guide for HUD Programs (issued by the HUD Office of the Inspector General), generally accepted auditing standards (GAAS), and Government Auditing Standards.
Environmental Regulations
Environmental regulations, like laws granting protection to wetlands, limit the available uses for designated parcels of land. Environmental remediation laws impose significant liabilities on those responsible for cleaning up contaminated property, and the presence of environmental contamination affects an entity's ability to sell its property.
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