In an effort to assist REITs and other public real estate companies in preparing their periodic reports filed with the SEC, we regularly review comments made by the staff of the SEC’s Division of Corporation Finance (the “Staff”) on Form 10-K and other reports filed by REITs, with a view to identifying new areas of focus for the Staff relating to REIT reporting and disclosure. In the past, we have noted the Staff’s focus on disclosure items ranging from occupancy rates and annual rents, use of FFO and other non-GAAP financial measures, and dividends and distributions in excess of FFO/cash flows. See Goodwin Procter’s March 25 and October 22, 2008 REIT Alerts. More recently, we have written about the Staff’s increasing acceptance of the use of common non-GAAP measures in the REIT sector, and the growing number of requests from the Staff that REITs disclose particular non-GAAP measures in their public filings. See “Mind the Non-GAAP” article, REsource, summer 2012.
As REITs and other public real estate companies enter the Form 10-K cycle for the year ended December 31, 2012, we are pleased to present the results of our review of comments issued by the Staff during 2012. We reviewed more than 40 publicly available comment letters issued to REITs on Form 10-Ks, 10-Qs, 8-Ks and furnished earnings releases across a broad variety of sectors, focusing primarily on those comments made on information presented outside of the relevant company’s financial statements. Unsurprisingly, the highest concentration of comments came in those areas identified by the Staff in early 20121, which in fact included a number of comments made during the 2010-2011 cycles as well. We expect the Staff’s focus for the coming year to be similar to its focus in 2012, though we understand that the Staff expects to share some refinements to its focus with NAREIT in early 2013.
For 2012, we found that the Staff most frequently sought additional disclosure or explanation concerning:
- use of non-GAAP financial measures in earnings releases and filed reports;
- presentation and calculation of same-store or same-property NOI;
- leasing activity generally, including a comparison of rates on new or renewed leases to prior rates;
- reflecting or otherwise quantifying tenant concessions and abatements in average rent amounts;
- breakdown of capitalized internal costs;
- development costs; and
- disclosure of activity under “at-the-market” offering programs.
Not all categories of comments were issued to every company and there were numerous miscellaneous comments that were issued only once or twice to select companies. Notably, in only a few instances did the Staff require a public REIT filer to amend its Form 10-K; rather, the Staff issued the majority of these comments as “futures comments,” which do not require an immediate amendment of an already-filed report but apply only to future filings. Below is a brief discussion of the most frequently issued comments during 2012.
The Staff's Comments
Active Review of Earnings Releases and Use of Non-GAAP Measures. In general, the Staff maintained its focus on the use of non-GAAP financial measures, commenting particularly on use of non-GAAP measures that are derived from other non-GAAP measures that have long been accepted in the REIT sector, such as FFO and NOI. The Staff particularly focused on non-GAAP measures that companies disclosed or referenced in their earnings releases but did not include in the filed Form 10-K or 10-Q, as applicable. For example, the Staff commented on use of FFO derivatives such as Adjusted FFO, Core FFO and Operating FFO and NOI derivatives such as “same-store GAAP NOI”, “cash NOI”, “stabilized NOI”, “consolidated property GAAP NOI” and “same store or same property NOI.” These comments generally first sought to determine whether the company believed the relevant non-GAAP measure was a key performance indicator useful to investors. If it was, the Staff generally requested that the measure be included in the company’s filed reports and reminded issuers of the requirements of Item 10(e) of Regulation S-K and Regulation G. Consistent with the Staff’s more accepting position in recent years on the use of common non-GAAP measures generally, the Staff focused more intently in the comments on use of non-GAAP measures that appeared to be particularly unusual or tailored.
In their responses to the comments, some companies successfully argued that while a particular measure appeared in their earnings release, it was not necessarily a key performance metric in the eyes of management warranting inclusion in filed periodic reports. Others conceded that the relevant measure was material but that either management was unable to predict critical components with sufficient accuracy (e.g., renewal rates) or that the data was confidential (e.g., tenant concessions). While the Staff appears to have pushed back on some of these responses but not others, we would generally expect the Staff to be less receptive to arguments that it is appropriate for a company to omit from its filed periodic reports disclosure of non-GAAP financial measures that are routinely and prominently disclosed in earnings releases and appear to be a focal point in management’s investor communications.
Focus on Same-Store NOI. With over 30 comments issued pertaining to the definition, calculation and use of same-store or same-property NOI, this was one of the most commonly issued comments during the 2012 review cycle. The Staff asked numerous REITs to explain whether they view same-store NOI as a key performance indicator and, if so, to disclose (i) same-store NOI, (ii) the calculations and methodology used in determining same-store NOI and (iii) a reconciliation to the most directly comparable GAAP measurement. The Staff further requested information about how companies determine the properties that fall within the same-store pool, and asked some companies to identify properties added to or removed from the same store asset pool and/or provide a breakdown of the same-store asset pool by sector (e.g., retail, office, etc.).
In some instances, same-store or same-property NOI was already being disclosed by the relevant company in its earnings releases and the Staff comment was a request to include it in filed periodic reports as well. In many cases, however, the company did not disclose or reference same-store or same-property NOI in its earnings release or otherwise and the Staff comment inquired generally if management considered it to be a material performance measure and, if so, to begin including it in filed periodic reports. As above, some respondents successfully argued that same-store or same-property NOI was not a key performance measure for management, while many companies receiving this comment agreed to include the requested disclosure in future periodic reports.
Leasing Activity. Another very common comment during the 2012 review cycle was a request for more robust disclosure of leasing activity generally. For example, the Staff requested more detailed disclosure relating to the volume and rental rates of new or renewed leases, rent escalators, tenant concessions, tenant improvement costs and leasing commissions. Many of the comments in this area focused heavily on the relationship between market/current asking rents and the rents on leases expected to expire in subsequent periods, and if the upcoming lease expirations would materially alter the company’s financial position. In some comments, the Staff also sought a discussion of the company’s historical occupancy rates and rent trends, adjusting for leasing incentives.
While many of the companies receiving this comment agreed to provide additional disclosure in future periodic reports, some companies successfully argued that disclosure of period-to-period leasing activity and trends is not material to investors. For example, in the healthcare sector, several REITs argued that disclosure of leasing rate trends by period would not be useful (and perhaps even confusing) to investors since healthcare leases are typically long term, account for a large percentage of building occupancy (if not 100%) and each tenant’s needs are generally unique and very specific. The Staff appeared to be less receptive to these arguments where the relevant asset class had multi-tenant characteristics as well (e.g., medical office).
Tenant Concessions and Abatements. The Staff issued more than 20 comments pertaining to disclosure of tenant concessions and abatements. The comments focused on average base rent per square foot and average rental rate per unit, requesting clarification on how or whether these amounts were calculated to reflect tenant concessions, such as free rent or tenant reimbursements. In cases where base rent was already presented on a GAAP basis, which includes the impact of tenant concessions and abatements, the Staff often requested further disclosure as to the extent and the impact of the concessions.
Development Costs. Where a REIT had disclosed the existence of properties under development, the Staff often requested disclosure of the anticipated completion date and budgeted costs for the development(s). For completed developments, the Staff requested disclosure of development costs per square foot or per unit and advised that future periodic reports should specify whether leasing costs were included in these figures. Most companies receiving this comment agreed to provide the requested information in future filings.
Capitalization Policies. Many comments addressed disclosures of capital expenditures and capitalized internal costs, with an emphasis on disclosure of the methodology used by the REIT to determine amounts to be capitalized. The Staff requested disclosure about the types of indirect costs that are capitalized as part of development and redevelopment activities, the amounts capitalized during the current period, and when the capitalization period begins and ends. The Staff often requested a breakdown of capitalized costs, including new development, redevelopment/renovations, capitalized interest, and capitalized payroll. In some comments, the Staff suggested disclosing this information in table format and including in narrative form a discussion of year-to-year fluctuations and expectations for the future.
Breakdown of ATM Program. For REITs with active at-the-market offering programs (or “ATMs”), the Staff requested periodic disclosure (on a quarterly and annual basis) of the amount of securities sold, the average price, gross proceeds, net proceeds, expenses and commissions. Comments also requested disclosure of how proceeds were used and the amount of unsold securities remaining in the program.
Capitalization Rates. In prior years, a comment made frequently by the Staff was a request that companies provide disclosure regarding the weighted average capitalization rates on acquisitions and dispositions, and how the capitalization rate was calculated. A number of companies successfully argued against providing this disclosure for reasons ranging from the proprietary nature of the information, its questionable usefulness to investors and the fact that such disclosure could also potentially be misleading. We note that, as expected, this comment did not reappear in the most recent Staff review cycle and we understand that the Staff has been willing to permit companies that began disclosing capitalization rates in their periodic reports in response to a prior comment by the Staff to discontinue doing so.
As companies begin preparing their next Form 10-K, they should be aware of the Staff’s focus in issuing comment letters and potentially be prepared to respond to a comment from the Staff if they are not planning to provide the disclosure requested in the comments described above.
1 See NAREIT’s SFO alert, “SEC Areas of Focus in Reviewing 2011 10-K Filings”, dated February 13, 2012.