AGH’s real estate practice serves some of the real estate industry’s largest investors, owners, and developers. Our professionals are specialized experts in navigating the complexities associated with the real estate assurance needs of investors, owners and developers. This means we can quickly gather pertinent data for audits without interrupting the flow of business. What distinguishes AGH’s ability to enhance your experience is our commitment to ongoing, open communication. We don’t just create a polished report — we work with our clients before and during the process to limit interruptions to their day-to-day business, while helping them proactively identify weaknesses in order to safeguard their real estate investments.
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AGH’s specific, technical real estate expertise means that we can quickly gather pertinent data for annual financial statement audits without interrupting the flow of business. Communication and an open partnership are the hallmarks of our auditing process to ensure that we meet clients’ needs completely and that we remain available to assist and answer any questions after an audit is finished. Year-end financial statement audits, which are required by equity partners, lenders or joint venture agreements, provide assurance that our clients’ financial statements are reasonably stated. We understand the need to minimize disruptions to our clients’ day-to-day business, so we work efficiently to complete required auditing and testing.
Our experience indicates that due diligence assignments not only provide another level of comfort to you the purchaser but often uncover opportunities or issues that were not previously noticed. These agreed-upon procedures must be well defined in order to complete the process within the ever shortening due diligence period. Our deep experience enables us to act swiftly in order to best benefit you throughout the purchasing cycle. Most important to the entire process is communication. We are in constant contact with you throughout the process so as not to waste a moment before the due diligence timeline expires.
Retail and office properties may require certain procedures specific to that asset class; however, even within asset classes, some properties have a particular nuance that requires special attention. We have found that understanding the specifics of each deal including the tenant mix and related information often generates additional questions and may define procedures specific to the property.
Initial general due diligence procedures include steps to:
- Compare leases to the lease abstracts
- Compare the lease abstracts to the underwriting rent roll
- Review prior years’ NOI and projected NOI to the budget and rent roll
- Note operating expenses trends
- Review CAM provisions in leases and management company calculations
- Test accounts receivable and prepaid rents for accuracy
- Detail capital expenditures for previous years
- Trace security deposit listing by tenant to the rent roll
- Abstract service provider contracts or trace contract terms to existing abstracts
Procedures specific to retail properties may include a lease review for blackout provisions if the anchor of a shopping center goes dark or a calculation of the shopping center income without the anchor. Office properties are more inclined to offer tenant improvement allowances on lease commencement which is often an overlooked liability when purchasing
Reporting on a significant real estate purchase is required by SEC Regulation S-X Rule 3-14. The 3-14 audit report and related footnotes generally outline the Net Operating Income of the project and certain other material factors. Often, much of the information necessary to complete these 3-14 audit reports can be obtained while in the due diligence process. Our ability to efficiently gather this information during due diligence is key to issuing the final report in a timely manner. Our approach to reporting begins by comparing the rent roll to the lease for major tenants. For commercial properties, recalculation of the ASC Topic 840 (formerly FAS 13) income effect would be necessary but is generally not applicable to residential properties. On the expense side, we would review the real estate tax bill and selected months of utility bills, recalculate the management fee, and test selected repairs and maintenance expenses. For complex properties, the report may include detail of income from other operations or a breakdown of general and administrative expenses. We aim to ease the burden for our clients in dealing with statutory reporting requirements, and our experience allows us to complete these audits without interrupting the workflow of your asset managers.
As you look for more value added opportunities to increase returns, development projects can be very attractive. As the equity partner in a development project, it can be difficult to stay on top of the mounting costs. Our clients frequently request a post-construction examination in order to determine whether project costs were fairly stated. These agreed-upon procedures generally begin with a basic understanding of the project and construction contract.
Building on that knowledge, we may review the subcontractor bidding process, invoices and payment applications where significant budget variances exist, change orders, payroll expenses for construction staff, equipment expenses whether owned by the contractor or leased, and physical build out review. These reports may be used to recover excess construction costs from the developer and as information for equity partners to consider as leverage in the next project with that developer.
AGH has found that common area maintenance expense audits are especially important in today’s economy. Whether tenant leases require an audited statement of operating expenses or landlords are working to manage revenue as much as possible, CAM is one area that can provide some additional benefits. An operating expense audit provides a level of confidence and support that the amounts passed through to each tenant are not only reasonable, but also complete. Management companies work hard to be sure to include every possible item in the expense recovery pool in order to maximize client recoveries, and AGH can help provide an assessment regarding the total expense items. In addition, tenants performing their own audits of expense items can be time consuming and costly. Preparing ahead of time by auditing the operating expense statement can reduce the potential loss as a result of a tenant conducted audit. A landlord prepared audit may also eliminate the possibility that tenants will pursue an audit of their own.
In today’s economy, percentage rent audits are a growing area of interest to our real estate clients. Our approach to a percentage rent audit begins with a thorough understanding of a tenant’s percentage rent reporting and payment requirements, whether the tenant is required to pay rent based on gross sales or net income, and whether the tenant is required to submit an independently certified sales statement. This basic understanding guides us through the engagement. Our second step is to request supporting information from the tenant, such as daily cash register tapes and bank deposit records to determine the completeness of the reported gross income. If required, we will examine inventory purchases and operating expenses by reviewing supporting purchase orders, invoices, contracts and allocation schedules.
Additionally, we perform analytical procedures, such as reviewing the tenant’s revenue from period to period, in order to advise our client on whether the revenue activity appears reasonable. We go the extra mile to help owners and property managers maximize revenue from percentage rent clauses.
AGH’s approach to an internal control review for third party management companies is similar to the internal control review performed for an annual financial statement audit. An engagement specifically designed to review internal controls is performed as an agreed-upon procedure and is a more comprehensive review of all aspects of the management company’s controls.
As with any agreed-upon procedure, we work with the client to determine the exact tasks to be performed. We gain an understanding of your specific areas of interest and what information is important to you. The responsibility for the design of the procedures rests with the client, so we work closely with you to help design thorough procedures producing the most helpful results. Once these factors are clear we can be assured that you will ultimately find the final report helpful. While the scope and objectives are different for each engagement, this initial process helps create the engagement plan.
In testing the internal controls of a third party management company, we begin with a detailed review and question / answer session with the management company controller covering every aspect of their system including employee duties, record keeping, and reporting responsibilities. Once we have an understanding of the system in general, we begin testing certain areas which require the most focused efforts. Among the most important areas of testing might be:
- Cash receipts – Our clients generally request that we test rental receipts for two randomly selected months. These amounts will be traced to bank statements, copies of tenant checks, tenant ledgers and accounts receivable reports.
- Cash disbursements – Using the same two months as our cash receipts tests, we review selected cash disbursements and trace the amounts to vendor invoices, cancelled checks, bank statements and accounts payable reports.
- Payroll – Payroll testing is performed to verify that management company employees are being properly charged to the property. We review selected payrolls and trace employee names, duties and pay rates to management company personnel files.
- Rent rolls – An incomplete or inaccurate rent roll may indicate a serious internal control problem. Too often a rent roll that is not properly managed leads to missed rent step ups, CAM obligations, or excess owner reimbursements for tenant improvements. Based on the tenant mix, we will review any number of tenant leases and trace the lease terms back to the rent roll.
These few steps provide a basis for how the engagement is performed. Other areas that may require testing include the protection of accounting and other sensitive data or recalculation of the actual management fee in accordance with the management agreement.
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