Published March/April 2013
I’ve been making wish lists at Christmas since I was a small boy – at times with modest success. However, since I began buying REIT stocks in the early 1970s, there have always been two items that Santa never seems to remember. These two wishes, if granted, would bring us REIT investors important information and would help to dispel the miasma of misunderstanding that often hovers over REITville.
My first wish is that REITs would disclose a detailed estimated net asset value (NAV) for their properties, hopefully even before “fair value accounting” is brought to our shores. This would be beneficial for REIT investors for several reasons – perhaps, most importantly, because the value of a typical REIT stock is largely determined, most of the time, by the market value of the properties it owns, less its debt and other obligations. Let’s be honest: REIT organizations have been real estate businesses for years, but few REITs are “growth” businesses. Certainly extra value can be created for shareholders through selective acquisitions and developments, but most of a REIT’s value is in its properties. For good reason, REIT shares have traded, over time, at very modest NAV premiums.
So NAV is really important for REIT investors. But it is not something that REITs disclose and must be estimated by investors and security analysts – who often don’t have the time or the expertise to do it properly, even when property-specific information has been publicly disclosed by the REIT. The result is that REITs’ all-important NAVs are, unfortunately, frequently ignored.
I concede that there is almost as much art as science in determining the value of a commercial real estate property. Although many properties are commodity-like, no two of them (or their locations, lease metrics or tenants) are exactly alike, and reasonable views on values will differ. Furthermore, determining a REIT’s NAV is just the starting point in REIT stock valuation – many other factors apply. But NAVs are really important, even if imprecise, and REIT organizations should disclose their estimates of them.
"These two wishes would bring us REIT investors important information and would help to dispel the miasma of misunder-standing."
The second long-ignored item on my wish list, which is another source of frustration to existing and would-be REIT investors, is the creation of a standardized definition of adjusted funds from operations (AFFO), sometimes referred to as “FAD” or “CAD.” NAREIT has done a fine job over the years of refining the concept of funds from operations (FFO), and almost all listed equity REITs disclose the NAREIT-defined figure quarterly.
But FFO, as NAREIT acknowledges, can differ significantly from the all-important free cash flow that can be deployed for property acquisitions, dividend payments and even share buy-backs. FFO doesn’t take into account such crucial considerations as rent straight-lining, regular and recurring tenant improvements and other capital expenditures needed to keep the properties competitive, and leasing commissions incurred to fill such properties with tenants. And often it’s very difficult for investors, due to lack of disclosure, to distinguish between capital expenditures that are necessary and recurring from those that truly add value to the property.
Certainly there are difficulties in standardizing a definition of AFFO – otherwise it would have happened already. But I am not advocating that we include such figures within the confines of GAAP rules. Rather, my wish is that NAREIT work with its member organizations to develop a reasonable definition of AFFO and ask all REITs to disclose it in a uniform manner.
If my wishes could somehow be granted, I suspect that confidence in REIT investing would expand even further, and the additional clarity in REIT-related data and information would draw in many more non-traditional REIT investors, both individual and institutional. Well, Santa, perhaps this year?