By Alyssa Pedersen

Impairment is one of the most judgment-intensive areas in real estate accounting, and it often arises during periods of operational or market stress. At its core, impairment addresses a fundamental question: Is a property still carried at an amount that can be recovered through future operations or sale? The answer has meaningful implications for financial reporting, debt compliance, investor relationships, and transaction outcomes.

What Is Impairment?

In real estate, impairment occurs when the carrying amount of a property (initial cost basis, less accumulated depreciation) exceeds its recoverable value. Under generally accepted accounting principles in the United States (U.S. GAAP) (ASC 360), long-lived assets such as buildings must be evaluated for impairment when triggering events indicate the asset may no longer be fully recoverable.

Common triggering events include:

• Sustained declines in occupancy or rental rates
• Operating losses or negative cash flows
• Adverse market or economic conditions (e.g., interest rate increases, capital market tightening)
• Physical damage or functional obsolescence
• A change in strategy, such as plans to sell or redevelop the property

Once a triggering event is identified, management is required to perform an impairment analysis.

How Impairment Is Evaluated

ASC 360 uses a two-step model for real estate assets:

1. 1. Recoverability Test
      The carrying value of the property is compared to the sum of undiscounted and unleveraged future cash flows expected to be generated over the remaining holding period, including eventual disposition.
      • If undiscounted cash flows exceed net carrying value, no impairment is recorded. Such cash flow projections consider factors such as expected future operating income, trends, and prospects, as well as the effects of demand, competition, and other factors.
      • If they do not, the asset is deemed impaired.
   2. Measurement of Impairment
      The impairment loss is measured as the excess of the carrying amount over fair value less cost to sell or cost of disposal, typically estimated using discounted cash flow models, market data, or appraisals.

Once recognized, impairment losses are permanent under U.S. GAAP and cannot be reversed, even if market conditions later improve.

Private Company Council (PCC) Considerations

Private companies are not exempt from impairment evaluation requirements. However, private companies often have greater flexibility in how fair value is supported. External appraisals are not explicitly required, and internally developed discounted cash flow models may be acceptable when based on reasonable, supportable assumptions.

A common misconception is that PCC elections allow private real estate entities to defer or avoid impairment recognition. They do not. Triggering events must still be evaluated, and potential impairment must be measured and recorded when indicated.

Why Impairment Matters

Impairment affects more than just reported earnings. Some examples of other impacts of impairment are:

Financial statement volatility: Impairment charges can be large and non-recurring, complicating trend analysis.

Debt covenants: Reduced asset values may impact loan-to-value ratios or net worth covenants.

Investor and lender perception: Impairment may signal operational challenges or broader market stress, even when driven by macroeconomic factors.

Transaction dynamics: Aligning book value closer to market value can influence sale pricing, equity distributions, and negotiations with buyers or partners.

Key Judgments and Risks

Impairment analyses rely heavily on management assumptions – future cash flows, capitalization rates, holding periods, and market rent growth. Small changes in these assumptions can materially affect the outcome of the overall analysis. Because of this subjectivity, impairment is often a high-risk area for bias, particularly when incentives exist to avoid or delay recognition.

Bottom Line

Impairment in real estate is not merely an accounting exercise; it is a financial reality check. While PCC alternatives can reduce complexity and valuation burden for private companies, they do not eliminate impairment evaluation and measurement requirements. Understanding when impairment is required, how it is measured, and how judgments are evaluated is critical to producing credible financial statements and making informed real estate decisions, especially in uncertain or shifting markets.

Contact Matthew Hausman, Miller Cooper Principal from our Real Estate group with any questions.