Why ffo for reit

Gains on sales of property do not add to a REIT's taxable income and should therefore not be included in the measurement of value and performance. Earnings per share is a company's net income divided by the outstanding equity shares. These measures also help investors determine whether the money is being used effectively by management. This calculation takes a REIT's FFO and subtracts any recurring expenditure that is capitalized and then amortized, as well as any straight-lining of rents.

These recurring capital expenditures may include such maintenance expenses as painting projects or roof replacements. In addition to AFFO, this alternate measure is sometimes referred to as funds available for distribution or cash available for distribution.

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Measure content performance. Develop and improve products. List of Partners vendors. Your Money. Some believe that adding back all depreciation and amortization shown on the GAAP income statement provides the clearest, most transparent and credible earnings measurement. Therefore, each of these numbers and their combination as the industry's potential supplemental performance benchmark are auditable based on GAAP.

This alternative produces a uniform, transparent and highly credible benchmark. At the same time, a significant shortcoming of this alternative is that the industry benchmark would include no capital maintenance charges - not even costs that are not "uniquely significant" to real estate operations or costs that relate directly to current and short-term revenue streams.

The most significant criticism of this alternative is that it does not result in depreciation and amortization of expenditures that are incurred to maintain the current revenue stream e. Alternative C: Same as Alternative B except that depreciation and amortization of all assets which clearly wear out over an identifiable, short period of time, or that clearly relate to identifiable, short-term revenue streams, would not be added back to GAAP net income.

Using this method to arrive at the industry's depreciation and amortization add-back would result in a charge to the supplemental benchmark for depreciation and amortization of expenditures required to maintain and possibly enhance the current- and near-term revenue stream. Some believe that this adjustment yields a more appropriate measurement of the economic profitability of operating real estate.

Others would prefer to not exclude these depreciation and amortization charges from the benchmark and rely on disclosures about on-going capital maintenance expenditures to provide investors and analysts with information to make appropriate adjustments. Alternative D: Same as Alternative B except that depreciation and amortization of all assets with depreciable lives of less than "X" years would not be added back. This alternative is similar to Alternative C, but rather than charging the industry benchmark with depreciation and amortization of certain types of assets, the charges are based on the depreciable lives of assets.

The depreciation and amortization of assets with lives less than a specific number of years e. While an initial reaction to this method is that a "bright line" would result in uniformity, many believe that in practice depreciable lives would be arbitrarily biased toward lives exceeding the "bright line.

Alternative E: Add back to GAAP net income the difference between: GAAP depreciation and amortization, and the amount of depreciation and amortization calculated using a method which results in what NAREIT and others believe is an appropriate depreciation and amortization charge to earnings e. This alternative results in a depreciation charge to the industry supplemental benchmark that the industry agrees should be appropriate under GAAP.

It produces a benchmark that the industry would hold out and promote as an appropriate GAAP net income number. Although neither of the two methods discussed below are GAAP today, the inclusion of one of these or another method in the industry supplemental performance measure may set the stage for its acceptance as GAAP in the future.

The industry would work with the appropriate accounting standard setters toward having the depreciation and amortization method selected under this alternative accepted as GAAP. The two such methods which have been promoted by the industry at various times and which have official acceptance outside the United States are: sinking fund depreciation salvage value depreciation Sinking fund depreciation is accepted under Canadian GAAP and is used by virtually all members of the Canadian Institute of Public Real Estate Companies to depreciate operating real estate.

Under this method, the cost of a property is depreciated in a manner similar to a principal amortization schedule on a long-term, fixed-rate mortgage. This, of course, results in increasing periodic depreciation charges over the life of the property - a pattern compatible with a property's increasing revenue stream.

There has been much written about the sinking fund depreciation method. The advantage of this method is that it is relatively simple and has been used for over 20 years by some NAREIT-member companies. The experience of these members would make implementation easier. Generally, this method results in a charge to earnings for the cost of a property in excess of its current fair value.

Properties are not written-up above cost under this method, but are not depreciated below fair value. Applying this method would require periodic valuations of property. These could be simple valuations of net operating income, without third party appraisers involved.

Many believe that this method of depreciation most faithfully represents the economic reality of operating real estate depreciation. It is also a method which is generally supported by the most recent position of the International Accounting Standards Committee IASC , a group that establishes accounting standards on an international basis.

The IASC is currently considering the issuance of an exposure draft that will require "investment real estate" to be carried on the balance sheet at fair value, not depreciated, and that changes in value be reported in the income statement.

A final vote on the proposed standard is expected this fall. The U. In addition to this global support, some believe that using fair value in the determination of depreciation for income producing properties is supported by current thinking with respect to fair value accounting for financial instruments. Those that take this position rely on the similarities of certain economic characteristics between long-term bonds and income-producing real estate. Regardless of which of the Alternatives A through E is selected, the Council believes that the industry supplemental performance measure should be defined in a manner that supports and encourages attestation by independent auditors.

Note on Presentation and Disclosure of Depreciation - Many analysts require a clear understanding of capital expenditures, tenant improvements, and leasing costs in order to calculate cash-based measurements of profitability. Regardless of the outcome of the Council's proposals with respect to the add back of depreciation and amortization, it will continue to be important for companies to provide information with respect to these types of on-going expenditures.

In addition, the amounts of depreciation and amortization that would be eligible and ineligible to be added back to GAAP net income to calculate the industry supplemental performance measure should be presented separately either on the face of the GAAP income statement or disclosed in the notes to the financial statements. The Council believes that these disclosures are vitally important and would encourage disclosure of these expenditures regardless of the alternative implemented.

Accompanying Disclosure The Council believes that sufficient disclosure accompanying the REIT industry's supplemental performance benchmark is critically important. As a result, the Council is considering what supplemental disclosures should be appropriate to accompany the REIT industry's supplemental performance benchmark.

Consistent with current practice and the existing definition of FFO, the Council believes that any adjustments to net income for unconsolidated partnerships and joint ventures should be disclosed on the same basis and calculated consistently with any final modifications.

The Council also believes necessary, accompanying disclosures should include the other disclosures recommended in the existing definition and clarification of FFO. Specifically, companies should reconcile the REIT industry's supplemental performance benchmark to GAAP net income and include a line item breakdown of each of the adjustments used in the calculation.

The reconciliation should be sufficiently detailed to provide investors with a material understanding of the differences between GAAP net income and the REIT industry's supplemental performance measure.

Additional disclosures also should include material capital expenditures, including tenant allowances, tenant improvements, capitalized leasing costs, expansions and major renovations, floor coverings, appliances, and exterior preparation and painting.

Depending on the circumstances surrounding an individual property, a disclosure should also be provided showing the non-cash effect of straight-line rents that affect periodic results.

The Council also believes that computation and publication of an individual company's industry supplemental performance measure should always be consistent with NAREIT's stated definition and that deviations should not be reported.

However, there is a difference between the depreciation expenses of real estate businesses and other businesses. In manufacturing or technology companies, one can make a case that as assets are being utilized they are likely to lose their value over time. However, that is not necessarily true in relation to real estate. Most real estate assets may appreciate over time.

As a result, depreciation expenses on the income statement could be misleading and represent an accounting loss of value rather than a market loss. Likewise, the gains and losses on real estate sales could also be misleading as these are purely accounting gains and losses and not actual cash flows. Funds from operations address both depreciation and gains and losses on real estate transactions refer to the formula below. As a result, there is some non-uniformity in how it is calculated.

The usual formula for FFO is:.