Accounting Treatment White Paper

Stake offers landlords and tenants an innovative solution to attract new residents, reduce turnover, incentivize timely rental payments, and help residents build savings. Through its loyalty platform, Stake offers cash or other rebate incentives to its members for paying rent on time (when they pay) and for saving their cash within the account (when they save). As a result of their rewards, many Stake members have more money in their Stake accounts than they do in their personal savings accounts. This translates into a portable and tangible benefit for timely payment and savings which the tenant retains at the end of the rental period.

The benefits to landlords are reduced rental turnover (thus, reducing marketing expenses, leasing commissions, free rent, lost rent, etc.) and more security over future rental payments (cash retained by the tenant in the Stake app which can be utilized for payment of future rent). As a result of the Stake Loyalty Program, owners have observed 7 – 15% increases in renewal rates, significantly reducing marketing and leasing commission expenses. Also, Stakes' partners have seen 4 times better response to ads that reference Stake’s Cash Back, helping them to lease faster, reduce downtime, and lower marketing and leasing commission expenses. Additionally, with Stake, owners of real estate see lower rates of delinquency.

Under the terms of standard Stake agreements with asset owners / managers, the owner will agree to reimburse Stake for cash incentives paid to renters as they undertake activities which trigger the receipt of payment. Owners have some discretion as to maximum levels of benefits that loyal members can achieve, but Stake retains full discretion on how and when those benefits are distributed. For example, an owner may agree to total benefits of up to 5% of face rent across a property. Based on Stakes' loyalty data, it may determine that a total loyalty benefit of 3% is sufficient to maximize rental renewals. Stake is paid on a fee basis, a percentage of the monthly rent residents pay their landlords.

The purpose of this white paper is to evaluate alternative views to the treatment of payments to Stake, and remittances to tenants, under current accounting literature. This white paper assumes the following:

  • Stakes' compensation under the arrangement (i.e. its percentage fee) is a genuine marketing expense of the property

  • The rental agreements impacted by Stakes' loyalty platform are Operating Leases as defined in ASC 842, and are not Sales-Type or Direct Financing leases

  • Owners have adopted ASC 842, Leases

Rewards to Stake Loyalty Members

Under the provisions of ASC 842, a lessor is required to assess lease incentives made to lessees at the outset of a rental agreement (i.e. free rent for a specified period of months). These incentives are to be capitalized at the outset of the lease and amortized as a reduction of rental revenue over the term of the lease. The authoritative guidance generally presumes the fact that under traditional lease incentives, the lessee is reasonably certain of the value of the incentive to be received (i.e. two months free rent) and offers no examples of accounting for variable payments made after the inception of a lease.

For properties deploying the Stake loyalty program, owners have a certain amount of discretion in assessing the amount of loyalty rewards Stake members would receive for qualifying activities. This is a major difference between the traditional incentive structure, as lease incentives are not paid at the outset of a lease.

ASC 842 does not offer guidance on how to recognize rewards to loyal members which are based on the outcome of future events outside of the owner’s control and which are neither paid nor payable at lease commencement.

View #1 – Lease Incentives

One view is that an owner should recognize a liability for its contingent obligation at the outset of the lease and amortize the liability as a reduction in rental revenue over the lease term. Should the expected level of benefit not be conferred to the tenant, the owner would reverse the liability, and any previously recognized reductions in revenue should be reversed through a cumulative-catch up adjustment. Given the nature of loyal member benefits provided through the Stake platform, which require compound actions to be taken on the part of the tenant (first, the payment of rent on time and second, the retention of benefit funds within their Stake accounts for a specified period of time), on a monthly basis, and which can be earned each month independently from any previous month’s actions, this would likely prove to be impracticable given the level of estimation uncertainty inherent in making any such estimates. Furthermore, evaluating and tracking the reversal and future recognition of any such benefits would likely prove to be administratively burdensome and would require substantial judgment on the part of the owner related to total benefits paid to tenants over the life of the lease over which they have limited control.

View #1 would reduce rental revenue and would reduce property-level NOI.

View #2 – Initial Direct Costs

An alternative view would be to consider Stake benefits as initial direct costs. ASC 842-10-30-9 defines initial direct costs as costs that may include 1) commissions or 2) payments to an existing tenant to incentivize to terminate its lease, which would not have been incurred if the lease had not been obtained. The nature of Stake loyal benefits does not fit the second example. However, as discussed previously, owners who deploy the Stake platform see a 4 times better response to ads that reference Stake’s Cash Back rewards. Additionally, these owners see lower rates of delinquencies and a substantial increase in lease retention (between 7% and 15%), it can be argued that the costs incurred by owners to reimburse Stake for loyal member benefits materially approximate costs incurred for leasing agents to identify new tenants. Furthermore, it can be reasonably assumed that if not for the engagement of Stake, owners would expect to incur associated leasing commission costs in order to fill vacant units.

ASC 842 requires lessors of operating leases to defer initial direct costs at lease commencement and amortize them over the lease term on the same basis as lease income. Consistent with the facts in View #1, identifying loyal member benefits as initial direct costs would require a significant degree of estimation on the owner’s part to assess the total amount of loyal benefits it would expect to reimburse Stake for related to the individual tenant over the lease period, and subsequently amortize those costs as expenses over the lease term (assumed to be a 12 month period).

Owners will need to assess whether an estimation of expected initial direct costs (the probability-weighted total reimbursements to Stake for loyal member benefits) at lease commencement materially differs from the recognition of these costs as period expenses (i.e. recognition of expense in the period paid to Stake depending on the actual benefits earned by the tenant).

In addition, it should be noted that certain accounting firms have published views regarding the treatment of lessee receipt of payments from third parties in connection with the execution of a lease. In those scenarios, which could include a leasing commission rebate, when it is determined that other GAAP guidance is not applicable, lessees should account for such payments as negative indirect costs. Therefore, it would be consistent to conclude that Stakes' payments of loyalty benefits to members would be treated as reductions in initial direct costs of a tenant. As such, it could be consistent to conclude that the payment of such costs by a landlord through a third-party would be similarly treated as initial direct costs.

View #2 would not reduce rental revenues but would generally be expected to reduce property-level NOI.

View #3 – Periodic marketing or other expenses

ASC 842-10-30-10 defines other costs which do not qualify as initial direct costs (emphasis added):

  • General overheads, including, for example, depreciation, occupancy and equipment costs, unsuccessful origination efforts, and idle time

  • Costs related to activities performed by the lessor for advertising, soliciting potential lessees, servicing existing leases, or other ancillary activities

  • Costs related to activities that occur before the lease is obtained, such as costs of obtaining tax or legal advice, negotiating lease terms and conditions, or evaluating a prospective lessee’s financial condition

Due to the number of benefits offered to Stake loyal members by virtue of a property offering the program, an argument can be made that the entirety of loyal member benefits can be treated as general marketing expenses. Owners actively advertise Stake’s program to attract new tenants to their properties, espousing the benefits of the portability of loyalty rewards to potential tenants. As demonstrated through Stakes' reduction in downtime and lease renewal rate increases, which should be compared against traditional landlord renewal efforts (including the provision of free rent), it can be concluded that the marketing of Stake drives traffic to owner’s buildings.

Additionally, while owners have some amount of discretion as to the amount of loyalty benefits that tenants can receive, Stake is fully responsible for the final benefit levels and their composition. This can come in the form of cash back, gift cards or other goods. Stake may also enter into direct partnerships with other financial institutions or investment brokerages to provide alternative savings methods for loyal members. The provision of the latter type of benefits would generally not be considered clearly or closely related with the underlying lease arrangement that the tenant enters into.

Furthermore, as tenants have the option, not the obligation, to participate in the Stake loyalty program, it can be argued that Stake benefits represents a variable marketing expense to owners, which would be recognized as a period expense as incurred.

View #3 would not reduce rental revenues and may have a positive impact on property-level NOI depending on each owner’s operating expense definition.

Conclusion

Based on the discussion above, it is clear that multiple views regarding the treatment of Stake loyal member benefits can be formed. Owners should carefully consider the guidance referenced within when arriving at a conclusion regarding the treatment of Stake loyalty benefits.


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