The Financial Accounting Standards Board is considering making incremental improvements to the disclosures surrounding fair value or mark to market accounting. The proposal currently under consideration will not be a material change to current rules – rather, it would be an enhancement on existing rules. Still, though, it is generating some controversy. To explain what this may mean for real estate paper, we turn to David Larsen, managing director at Duff and Phelps.

GlobeSt.com: Explain the suggested change please.

Larsen: FASB is proposing a requirement that companies disclose a range of possible valuations for certain assets in cases where an established, liquid market does not exist.

GlobeSt.com: And where is it now in the process?

Larsen: It’s been in the comment stage for about a month now. That’ll end by October 12.

GlobeSt.com: Now, as I understand it, this is not as a significant a proposed change as FASB’s ongoing deliberations on financial instruments and how they should be treated.

Larsen: Yes, that’s true. When that guidance comes out – which won’t be until 2010 or 2011 – it could be a major change.

GlobeSt.com: But this proposed change – the one we are discussing on possible valuations in an illiquid market -- will also have an impact, assuming it is adopted?

Larsen: The proposed change is in the disclosure – but some are questioning whether the changes make sense. Not all of the changes are controversial, though, I have to say. For instance, one would require if an input moves from Level 1 to Level 2, it must be explained why. [Editor’s note: briefly, in its 2006 FAS 157 standard, FASB established a three level hierarchy for assets. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Level 2 are “observable” assets or liabilities and Level 3 are assets for which the market is essentially illiquid]. What is creating the most questions is the provision that says if you value something using Level 3 inputs and there are reasonable possible alternatives and those alternatives would result in a significant difference in the value, then you have to disclose those alternatives and the impact on fair value assessment.

GlobeSt.com: Where is most real estate paper right now?

Larsen: Prior to everything freezing last year much of it was at a Level 2 – meaning their valuations were driven by cash flow models and various assumptions that were not as observable in the market. Today most of it is at a Level 3.

GlobeSt.com: How would the rule be applied today if it were in effect?

Larsen: Let’s say you have an office building. To value it, you look at the term of the lease, its comps and come up with a value. Let’s say I come up with a value of ‘100’ because of all the different characteristics. But it also could conceivably be ‘75’ or ‘120’, depending on the economy – say retail sales are better this holiday season and there is a significant retail component to the office building. So what happens is that you have the potential to raise a Pandora’s box of second-guessing. Shareholders can ask why the ‘75’ or ‘120’ wasn’t included in the financial statements for instance.

GlobeSt.com: Why is FASB suggesting this rule change?

Larsen: It believes investors want it – and the additional information could would helpful. But critics say it may be too much information and confuse matters.