© 2019 rsm us llp. all rights reserved. · 2019-07-16 · •identify the key provisions of asc...


VIE CONSOLIDATION RULES

NAREC 2019 Annual Conference

June 19, 2019

© 2019 RSM US LLP. All Rights Reserved.

Speaker

Minneapolis, MN

612.376.9324

[email protected]

Brandon Maves

Partner, National Construction Leader

3


Agenda

Topic Minutes

Overview 10

Case Studies 55

Q&A 10


Objectives

By the end of this session, you will be able to:

• Identify the key provisions of ASC 810 impacting

real estate and development joint ventures

• Address ASC 810 for your financial reporting


OVERVIEW


VIE Definition

An entity is considered a variable interest entity

(VIE) if:

1. The total equity investment at risk is not

sufficient to permit the legal entity to finance

its activities without additional subordinated

financial support provided by any parties,

including equity holders.

OR


VIE Definition


(VIE) if:

2. As a group the holders of the equity

investment at risk lack any one of the following

three characteristics:

a. The power, through voting rights or similar rights,

to direct the activities of the JV that most

significantly impact the entity’s economic

performance


VIE Definition


(VIE) if:

2. As a group the holders of the equity

investment at risk lack any one of the following

three characteristics:

b. The obligation to absorb the expected losses of

the JV

c. The right to receive the expected residual returns

of the JV

OR


VIE Definition


(VIE) if:

3. Both of the following exist:

a. The voting rights of some investors are not

proportional to their obligations to absorb the

expected losses of the legal entity, their rights to

receive the expected residual returns of the legal

entity, or both.

b. Substantially all of the legal entity’s activities either

involve or are conducted on behalf of an investor

that has disproportionately few voting rights.


LLC/LP Rule

A LLC or LP is not a VIE if either of the two

conditions below is met:

1. A single limited partner, partners with a simple

majority of voting interests or partners with a

smaller voting interest with equity at risk are

able to exercise substantive kick out rights.

2. Limited partners with equity at risk are able to

exercise substantive participating rights.

This is a high hurdle, so …..

11


most JVs are:

VIEs 12


Primary Beneficiary

A reporting entity is a primary beneficiary of a JV

if it has both of the following characteristics:

1. The obligation to absorb losses of the JV that

could potentially be significant to the JV or the

right to receive benefits from the JV that could

potentially be significant to the JV.

2. The power to direct the activities of a JV that

most significantly impact the JV’s economic

performance.

13


CASE STUDIES


Definitions

Joint venture: The entity holding the property.

Developer: Minority investor, responsible for

development services and

oversight of construction

Investor: The majority investor with little

development and real estate

holding.

Operator: Minority investor, provides day-to-

day operating services.

15


Assumptions

• The joint venture (JV) is structured as a limited

liability company (LLC) or limited partnership

(LP).

• The JV does not qualify for any scope

exceptions under ASC 810.

16


Senior Housing - Pristine Meadows


Senior Housing – Pristine Meadows

18

Pristine Meadows, LLC

PM LS MSH LLC

DevCon Inc.

(Developer – 5%)

Senior Lifestyles, Inc.

(Operator - 5%)

MSH REIT

(Investor- 90%)



Roles:

DevCon:

1. Partial development originator

2. Developer and general contractor

3. Managing member of PM LS MSH LLC

4. Investment of $2M

5. Provides a completion guarantee and a

construction loan guarantee ($40M).

19



Roles:

Senior Lifestyles, Inc:


2. Operator of finished project


4. Responsible for marketing of the project while

under development

20



Roles:

MSH REIT:


2. Operator of finished project


21



Key LLC agreement terms:

− DevCon is the managing member and may make all

day-to-day decisions and all other decisions except

for Major Decisions (defined).

− Senior Lifestyles and MSH make no day-to-day

decision.

− Majority vote is required to approve all Major

Decisions.

− No kick-out rights held by any member.

22



Major Decisions:

− Original design of the project and any changes.

− Original construction and development contract and

any changes greater than $10,000.

− Original operating and capital budget.

− Annual approval of the budget and annual business

plan.

− Approval of all Material Contracts (property

management, development, financing, operating,

maintenance, etc.)

23



Is Pristine Meadows LLC a VIE?

Yes Why:

The presence of a loan guarantee is considered

subordinated financial support.

24



Significant economic activities (power criterion):

− Requires significant judgment

− The ability to exercise is required even if never

elected.

− How does a decision impact…

• Revenue?

• Cash flow?

• Fair market value?

25



Significant economic activities:

− Control over the construction activities

• Design changes

• Construction budget changes

− Financing

• Terms

• Conversion from construction to permanent loan

− Leasing

• Criteria and type

• Rent rates

26




− Marketing

− Operations

• Services offered to residents

• Hiring and firing of property manager, operator, asset

manager

27



Absorb losses:

DevCon ($42M):

− Loan guarantee

− Direct investment

Senior Lifestyles ($2M):


Receive benefits:

DevCon:

− Cash flow from

operations

− Sales proceeds

Senior Lifestyles:

− Cash flow from

operations

− Sales proceeds

28



Absorb losses:

MSH ($20M):


Receive benefits:

MSH:

− Cash flow from

operations

− Sales proceeds

29



Construction activities

Financing

Leasing

Marketing

Operating

DevCon & MSH

MSH

Senior Lifestyles & MSH



30

Power to direct significant economic activities:



Power to direct significant economic activities?

MSH Why:

Under the governing documents none of the

significant economic activities can be enacted,

changed or enforced without MSH involvement.

31




Specific provisions:

• Construction plans and designs, including any

changes

• Annual business and operating plan

• Capital and operating budgets.

32


Multi-Use – The Landing



34

The Landing, LLC

DevCo

(Developer)

Fund

(Investor)



35

The Landing, LLC

Hotel

DevCo – 50%

Fund – 50%

Office

DevCo – 15%

Fund – 85%

Condos

DevCo – 85%

Fund – 15%



Roles:

DevCo: 1. Development originator

2. Managing member of The Landing, LLC

3. Developer and responsible for leasing and condo sales.

4. Investment of $55M • Hotel - $30M

• Office - $10M

• Condo - $15M

5. Provides a completion guarantee and a loan guarantee ($270M).

36



Roles:

Fund:

1. Investor


• Hotel - $30M

• Office - $70M

• Condo - $5M

3. Can put equity in condo portion 12 months after

completion and hotel portion 24 months after

opening.

37



Key LLC agreement terms:

− DevCo is the managing member and may make all

day-to-day decisions and all other decisions except

for Major Decisions (defined).

− Majority vote is required to approve all Major

Decisions.

− No kick-out rights held by any member.

38



Major Decisions:

− Original design of the project and any changes.

− Original construction and development contract and

any changes greater than $100,000.

− Original operating and capital budget.

− Annual approval of the budget, condo sales, and

business plan.

− Approval of all Material Contracts (property

management, development, financing, operating,

maintenance, hotel flag etc.)

39



Is The Landing LLC a VIE?

Yes Why:

The presence of a loan guarantee is considered

subordinated financial support.

40



Significant economic activities (power criterion):

− Requires significant judgment

− The ability to exercise is required even if never

elected.

− How does a decision impact…

• Revenue?

• Cash flow?

• Fair market value?

41




− Control over the construction activities

• Design changes

• Construction budget changes

− Financing

• Terms

• Conversion from construction to permanent loan

− Leasing

• Criteria and type

• Rent rates

42




− Marketing & Sales

• Condo sales prices and incentives offered

− Operations

• Hiring and firing of property manager, hotel operator, asset

manager

43



Absorb losses:

DevCo ($325M):

− Loan guarantee


Fund ($105M):


Receive benefits:

DevCo:

− Cash flow from

operations

− Sales proceeds

Fund:

− Cash flow from

operations

− Sales proceeds

44



Construction activities

Financing

Leasing

Marketing

Operating

DevCo & Fund

Fund

DevCo & Fund

DevCo & Fund

DevCo & Fund

45

Power to direct significant economic activities:




Fund Why:

Under the governing documents none of the

significant economic activities can be enacted,

changed or enforced without Fund involvement.

46




Specific provisions:

• Construction plans and designs, including any

changes

• Annual business and operating plan

• Capital and operating budgets.

47



Silos (ASC 810-10-25-57 & 58):

− (57) A reporting entity with a variable interest in

specified assets of a VIE shall treat a portion of the

VIE as a separate VIE if the specified assets are

essentially the only source of payment for specified

liabilities or specified other interests. (The portions of

a VIE referred to in this paragraph are sometimes

called silos.) That requirement does not apply unless

the legal entity has been determined to be a VIE.

48



Silos (ASC 810-10-25-57 & 58):

− (58) A specified asset of a VIE and a related liability

secured only by the specified asset or group shall

not be treated as a separate VIE if other parties have

rights or obligations related to the specified asset or

to residual cash flows from the specified asset. A

separate VIE is deemed to exist for accounting

purposes only if essentially all of the assets,

liabilities, and equity of the deemed VIE are separate

from the overall VIE and specifically identifiable.

49



So what does this mean to The Landing LLC

arrangement?

If the loans were segregated for recourse against

each component (office, hotel, condo) and only

that component (95% threshold), you would need

to evaluate if a silo existed and who was the

primary beneficiary of each silo.

50



So what does this mean to The Landing LLC

arrangement?

This would be particularly relevant if the Fund

exercises its put option on the hotel or condos.

− Event of reconsideration.

− Loans structure crucially important.

51


PHASE CONSIDERATIONS


Phase considerations – Origination & Design

Characterized by little substantive activity at the joint venture level, however considerations in design of the entity. Considerations such as:

• Funding sources and allocation.

• Loan negotiations, particularly guarantees

• Commitments to fund construction/development overruns

• Which party will govern various aspects of the development, construction and stabilized operations.

53


Phase considerations – Construction

This phase is characterized by a high level of activity with substantial impact over the properties end design which will impact the joint venture’s current status and future operation. Considerations such as:

• Who controls the design decisions on the property and development? Who approves change orders?

• Who approves changes to the construction budget, including sources and uses? − Approval or veto rights of the construction budget (ASC 810-20-25)

would generally have a significant impact on the joint venture and the property.

− What happens if no agreement can be reached?

• Who acts as the construction manager or who can approve the hiring/removal of the construction manager?

•

54


Phase considerations – Lease-Up | Stabilization

The emphasis of the joint venture moves away from construction and property development to sales and marketing and finalizing any significant changes to what will become stable operations. Considerations:

• Who performs the marketing and sales roles, particularly pricing of units (sales) and tenant approval and leasing.

• Who sets initial lease-up budget? Who approves/vetoes? What happens if no agreement can be reached?

• Who acts as the property manager and what rights does the property manager have?

55


Phase considerations – Stabilized Operations

Focus on the joint venture is on maximizing cash flow to support an exit price. Considerations:

• Who sets the annual budget? Who approves/vetoes? What happens if no agreement can be reached?

• Who can initiate and approve the sale of the property and dissolution of the joint venture? What happens if no agreement can be reached amongst the members? (Protective Right)

• Who is responsible for re-marketing and redeveloping the property, should this be required?

• Who can place indebtedness on the property and distribute the debt proceeds? (Protective Right)

56


57


This document contains general information, may be based on authorities that are subject to change, and is not a substitute for professional

advice or services. This document does not constitute audit, tax, consulting, business, financial, investment, legal or other professional

advice, and you should consult a qualified professional advisor before taking any action based on the information herein. RSM US LLP, its

affiliates and related entities are not responsible for any loss resulting from or relating to reliance on this document by any person. Internal

Revenue Service rules require us to inform you that this communication may be deemed a solicitation to provide tax services. This

communication is being sent to individuals who have subscribed to receive it or who we believe would have an interest in the topics

discussed.

RSM US LLP is a limited liability partnership and the U.S. member firm of RSM International, a global network of independent audit, tax and

consulting firms. The member firms of RSM International collaborate to provide services to global clients, but are separate and distinct legal

entities that cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other

party. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International.

RSM, the RSM logo and the power of being understood are registered trademarks of RSM International Association.


RSM US LLP

801 Nicollet Avenue, 11th Floor

Minneapolis, MN 55402

612.332.4300

+1 800 274 3978

rsmus.com

© 2019 rsm us llp. all rights reserved. · 2019-07-16 · •identify the key provisions of asc...

Documents