First-Time Fund Audit FAQ for Real Estate Fund Managers

Preparing for a first audit can feel overwhelming for real estate fund managers. Questions around valuation support, timing, waterfalls, internal controls, and documentation often arise early. This FAQ addresses the questions we hear most often and outlines what managers can do to make the audit process more efficient and predictable.

What Should You Know Before a First Real Estate Fund Audit?

Q: How long will our first audit take?

A: The time needed on every audit is dependent on several factors, but early planning with the auditor to set expectations and timing is the key to running a smooth audit and issuing it by the deadline. Common reasons for delays include not engaging an auditor early enough, not dedicating time to respond to audit requests, and not having the necessary support. By engaging an auditor early, you can agree on a document request list and schedule.

Q: How does a fund audit differ from a property audit?

A: Under US GAAP, a fund that meets the characteristics of ASC 946 reports its investments at fair value on its balance sheet and gains/losses, both realized and unrealized, on its income statement. A property, meanwhile, is likely reporting its operations showing the real estate at historical cost, along with outstanding loan balance, receivables and payables on its balance sheet and rental income, operating expenses, interest, and depreciation on its income statement.

Accordingly, a fund audit will be focused on the valuation of real estate investments and capital rather than the operating results of the properties.

Q: How closely will our property valuations be scrutinized?

A: Valuation of real estate investments is inherently subjective, which makes it a significant focus of the audit. Auditors will review corroborating evidence such as market data, lease agreements, debt agreements, and invoices, etc., to test management’s assumptions.

Q: What happens if the auditor disagrees with a valuation or has other concerns?

A: Part of testing property valuations is challenging management’s assumptions when they do not align with market conditions or historical results. However, this does not mean that management’s conclusion is wrong. The auditor will set up a meeting with management to talk through any identified differences and will give management the opportunity to support its position with verifiable data. If management’s assumptions are not supported, this may result in an adjustment to the valuation.

Q: Do we need a fund administrator to get through an audit?

A: No, a fund administrator is not a requirement to complete an audit. What matters to the auditor is that the fund's books and records are complete, accurate, and supportable — regardless of whether that function is performed in-house or outsourced to a third-party administrator. An administrator typically helps with tasks that directly support the audit, such as maintaining the general ledger, calculating capital calls/distributions and management fees, preparing capital account statements, and providing NAV packages to management. Ultimately, the decision comes down to the fund’s complexity and the strength of the manager's internal accounting infrastructure and controls. If the fund manager can demonstrate strong internal controls, timely and accurate financial records, and sufficient staff capacity, an audit can be completed efficiently without a third-party administrator. If any of those are lacking, an administrator can help fill the gap and reduce audit risk/delays.

How Do You Choose an Auditor and Prepare?

Q: How do we choose an audit firm with real estate experience?

A: Real estate fund managers should look beyond whether an audit firm has general fund audit experience and also focus on the depth of its experience within the real estate asset class specifically. A strong audit firm should not only understand complex fund structures, partnership agreements, waterfall calculations, and property valuations, but also understand real estate operations, including property types, investment strategies, and market dynamics that drive investment performance.

Q: What information should we have ready for the auditor?

A: Once engaged, an auditor will request the Fund’s governing documents, including the executed partnership agreement and private placement memorandum. They'll also request documents related to investment acquisitions and investors, such as subscription agreements and relevant side letters. The auditor will then prepare a formal request list and meet with you and your fund administrator to determine who is responsible for providing each item and to agree on a timeline.

Q: Will the same firm handle our tax filings, too?

A: Audit and tax services are not required to be with the same firm; however, there are efficiencies to working with one firm.

Q: What if we don't have formal internal controls documented yet?

A: Management is responsible for the design, implementation, and maintenance of internal controls over financial reporting; however, it is not required to be formally documented in writing. The auditor is required to obtain and document their understanding of the entity’s system of internal controls and evaluate the design and implementation of certain relevant controls. If this is not formally documented, the auditor will schedule meetings with the various process owners in order to understand the processes in place.

How Does Fund Structure Affect the Audit?

Q: Do we need audited financials for every property-level entity?

A: There is no requirement for a fund manager to obtain an audit for each investment property. However, having audited financial statements at the property level can reduce the amount of testing and supporting documentation required by the fund auditor, particularly for investment valuation testing. If the properties are not audited, the fund’s auditor will perform limited procedures to gain comfort of the property’s operations to the extent that operations will impact valuation (e.g., net operating income is utilized as part of the income approach).

Q: Does the fund’s auditor also audit the properties?

A: Many properties require an audit under their loan agreement or operating agreement. While these audits can be done by another auditor, there is efficiency in using the same auditor as the fund.

Q: Are there special considerations when there is a REIT or blocker within the fund structure?

A: Real estate funds organized as REITs are generally outside the scope of ASC 946 and follow an operating-company reporting model rather than investment company accounting. Blocker entities, however, may or may not qualify as investment companies depending on their specific facts and circumstances. Financial reporting considerations include evaluating whether consolidation is appropriate, assessing the applicability of ASC 740, income tax accounting for taxable blockers, and monitoring compliance with REIT qualification requirements when a REIT is used within the structure. Because these analyses are highly fact-specific, the accounting outcome may vary based on the reporting entity and the overall fund structure.

How Do Auditors Test Real Estate Fund Valuations?

Q: Do all our properties need third-party appraisals?

A: A real estate fund reporting under ASC 946 is required to present all their real estate investments at fair value. US GAAP does not require a third-party appraisal to support that fair value determination. Management can prepare the valuation model internally, provided it has the experience and knowledge, it complies with ASC 820 (Fair Value Measurements), and it is auditable and supportable. Whether an organization uses an external appraisal or an internally prepared model, the auditor will test the model along with its inputs and assumptions

1. Q: How does our property JV agreement affect our valuation?

A: Once the fair value of the joint venture is determined, the value that the Fund records is generally not just a pro-rata share of the property's value. The JV agreement's economic terms, such as the distribution waterfall, promote/carried interest structure, preferred returns, and any capital call or funding obligations, will impact the fund's interest. Determining the fair value of the joint venture is just the first step of the analysis. The value then has to be allocated to various partners based on the methodology prescribed in the JV agreement.

Q: Does a property still under development need a valuation?

A: Technically speaking, all investments need to be recognized at their fair value. A development project should recognize appreciation as the project de-risks since that project will now be more valuable to market participants. For example, land that has obtained entitlements is worth more than land that cannot be built on. Therefore, a typical development valuation model will consider the value upon completion and then discount that value back to the valuation date utilizing factors such as, time left to completion, major milestones met and remaining completion costs. It may be that the cost approximates fair value at the valuation date, but the auditor will want to review the valuation model to support that assertion.

Q: What are the deliverables needed to provide to the auditor?

A: A fund manager should provide the valuation model, valuation memo, calibration analysis, and support for the key assumptions. The valuation memo should describe the property, its investment strategy, activity during the year, and provide the detail of the key assumptions that were selected (e.g. comparable rents, rent growth, operating expense growth, cap rates, discount rates, etc.). The calibration analysis (which can also be built into the valuation memo) reconciles the change in value since the last valuation or underwriting and includes a retrospective review of prior assumptions versus actual results. Providing a well-thought-out package upfront will streamline the audit process, requiring less follow-up with the investment team.

How Do Auditors Review Waterfalls and Carried Interest?

Q: We haven’t realized any investments. Do we need to recognize carried interest?

A: The answer depends on how the fund’s governing document is written. Generally, allocations of profits are based on a hypothetical liquidation. A hypothetical liquidation assumes that as of the reporting date, all assets are sold at their current book value (typically fair value for investment funds), all liabilities are settled, and the remaining net assets are distributed in accordance with the fund's liquidation waterfall. Under this approach, carried interest may be allocated and recognized even though the underlying investments have not yet been sold. The key consideration is not whether an investment has been realized, but whether the governing document requires an allocation of profits to the carried interest holder as of the reporting date.

Q: What support do we need for our distribution waterfall?

A: The fund manager or administrator should provide the carried interest schedule along with the executed governing documents and related side letters. This allows the auditor to independently recalculate the calculations and confirm that they are consistent with the fund’s governing terms.

Prepare for Your First Audit With EisnerAmper

The right auditor brings more than audit experience. They understand your fund structure, your investments, and the real estate operations behind them. EisnerAmper’s real estate professionals bring that perspective to help managers navigate their first audit and the challenges that follow throughout the fund’s lifecycle. If you are preparing for an audit or simply want to understand what to expect, our team can walk through your fund structure and valuation approach to give you clarity and confidence throughout your first audit. Get started below, contact our team.