A question popped up during a meeting of some real estate compliance folks talking about Form PF. How do you treat subsidiary mortgage borrowings? Question 12(a) asks for the dollar amount of borrowings for the fund. Two main issues came into play: write-downs and recourse.
As many real estate funds are still recovering from the 2008 financial crisis they may have some properties that are underwater. They could have debt in excess of the value of the property. If the loan obligation is isolated at a property and the recourse is limited to the subsidiary then the investment would have a negative valuation. For accounting treatment, the loan value is likely written down to the fair value of the property. That results in a zero valuation rather than a negative valuation.
When Form PF asks for the value of the borrowing should you include the full value or the written down value? Italics means there is a definition and it refers to Instruction 15.
15. May I rely on my own methodologies in responding to Form PF? How should I enter requested information? …
for … borrowings where the reporting fund is the debtor, “value” means the value you report internally and to current and prospective investors;
So the value of a mortgage borrowing should be reported based on the value you report internally and to current and prospective investors. If you write down the mortgage in your annual report, then you can write down the value of the mortgage on Form PF.
That leads to the next question, which is whether to include the debt at all. Without recourse the borrowing is not a direct obligation of the fund. You could argue that the mortgage debt is not part of the “reporting fund’s borrowings.”
A private equity fund would likely not report the value of debt owed by portfolio companies unless the debt were recourse to the fund. I’m not sure that the position changes when the investment is a single real estate instead of an operating portfolio company.
There is the fallback in question 4 which allows you to explain any assumptions you made in responding to questions. You could include all of the debt and state that it includes non-recourse debt. Or take the opposite approach and exclude the non-recourse debt but explain that you excluded non-recourse debt from the answer.
A third question was how to treat debt on joint venture properties. Most seem to agree that you would only include your proportionate share of the debt. Again, you could make arguments either way.