Public real estate investment trusts (REITs) with significant acquisition and disposition activity are generally subject to either Rule 3-05 or Rule 3-14 of Regulation S-X depending on the circumstances of each property transaction. Both rules were amended on May 20, 2020, with an adoption date effective beginning January 1, 2021. Both rules look at yearly acquisition and disposition activity to determine if property level financial statements are required to be filed with the SEC. The below analysis will focus on the amended Rule 3-14 acquisition activity as this is highly relevant to the operations of a REIT.
Step 1: Is the target acquisition property a real estate operation?
If yes – move to step 2. If no – STOP and analyze under Rule 3-05.
The SEC defines a real estate operation as a business that generates substantially all of its revenues through the leasing of real property.1
While there is no clear rule for the classes of property acquisitions that qualify as a real estate operation, SEC staff guidance confirms that properties that would be considered a real estate operation include office, apartment, and industrial buildings, as well as shopping centers and malls.
Properties that generate revenue from operations other than leasing such as hotels, motels, nursing homes, golf courses, auto dealerships, and equipment rental operations generally would not be considered a real estate operation.
Step 2: Does a scope exception exist?
If yes – STOP. If no – move to step 3.
REITs that acquire properties with less than three months of rental history are not required to provide acquisition level financial statements to the SEC. Examples include sale-leaseback deals and newly constructed property acquisitions.
Step 3: Does the target acquisition property pass the significance test?
If yes – REIT is required to provide target acquisition property financial statements to SEC.
SEC guidance clarifies that the target acquisition property is significant if it exceeds a 20% threshold using the investment test outlined in C.F.R. § 210.1 (2022). The investment test is defined as follows:
Significance = target acquisition property investment (TAPI) ÷ aggregate worldwide market value (AWWMV)
Where:
TAPI: generally calculated as the fair value of the consideration paid for the property.
AWWMV: generally calculated as the average of the daily last five trading days of the market value of the REIT’s voting and non-voting common equity for the most recently completed month prior to the acquisition date.
*If AWWMV is not readily available (I.E., the REIT is a pre-IPO), the SEC states that the value of total assets from the most recently completed fiscal year can be used.
Related property acquisitions
If a REIT acquires a group of related property acquisitions, it must aggregate the TAPI when performing the investment test as if the group of related properties were a single acquisition. The SEC defines a group of related property acquisitions if any of the following is met:2
- The property acquisitions are under common control or management; or
- The acquisition of one business is conditional on the acquisition of each other business; or
- Each acquisition is conditioned on a single common event
Aggregation of insignificant acquisitions
Under Rule 3-14, REITs must also provide aggregate level financial statements within registration statements or proxy statements for individually insignificant property acquisitions that pass the aggregation test. REITs are required to aggregate all individually insignificant property acquisitions not meeting the 20% significance test, and if the significance of the aggregated properties exceeds 50%, REITs are required to file certain property financial statement disclosures with the SEC.3