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REITs: Non-GAAP Measurements Face SEC Scrutiny

An article in today’s New York Times reports on a potentially troubling phenomenon of tech companies increasingly using non-GAAP numbers to promote financial performance. “Tech Companies Fly High on Fantasy Accounting“, quoting analysts and investors, further reports that the cumulative difference between GAAP and non-GAAP earnings figures reached $46 billion in 2013.

While the use of non-GAAP metrics by tech companies has received significant media attention in the past few years, non-GAAP accounting at REITs (real estate investment trusts) has so far triggered less interest. A recent post at Seeking Alpha, citing Annaly Capital Management (NYSE: NLY) as an example, suggested that the frequent use of non-GAAP among these entities can be related to the complex accounting and business models employed by the REIT industry.

The National Association of REITs, called NAREIT, promotes a “supplemental industry-wide standard measure of REIT operating performance that would not have certain drawbacks associated with net income under generally accepted accounting principles (“GAAP”)”. Funds from Operations, or FFO, is one such mesure. It is defined as net income (computed in accordance with GAAP), excluding gains (or losses) from the sale of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. In practice, however, an even further-adjusted version of the metric is frequently used. The variations of the metric include language such as “core”, “normalized” and “adjusted” FFO, which is called Adjusted FFO or AFFO.

According to research performed by Audit Analytics, each of the 21 REITs included in the S&P 500 Index used at least one non-GAAP metric in their earnings statements. Among them, FFO, AFFO, Funds Available for Distribution (FAD), and Adjusted EBITDA were the most commonly used.

The table below provides some insight into the presentation and use of AFFO:

AFFO reconciliations to GAAP Net Income can be very involved. Some companies have as many as 20 reconciling items in their AFFO presentations. Most reconciliations include items such as impairment losses and gains on the extinguishment of debt.

In July and August, a number of SEC Comment Letters directed at REITs became available to the public on EDGAR. So far in 2015, 110 REITs received comment letters. In more than 40% of cases, the review addressed non-GAAP metrics, with the use of FFO, AFFO, and FAD all drawing inquiries. For comparative purposes, in 2014, 190 REITs received comment letters and only 44 of them (or about 23%) received a non-GAAP comment.

So what was the focus of the SEC review? At least some of the comments focused on clarifying inconsistencies between FFO disclosed by the companies and NAREIT’s definition.

Comment: We note that your calculation of FFO includes an adjustment for gain on insurance settlement. Please tell us whether management determined that this adjustment is in compliance with NAREIT’s definition of FFO. Please tell us management’s consideration for presenting an FFO, as an adjusted amount.

Other comments questioned whether the classification of certain adjustments as “non-recurring” was warranted, given the nature of some of them.

5. We note your disclosure that FFO is adjusted to eliminate the impact of non-recurring items when calculating AFFO. Given the nature of these adjustments, it is not clear why they are non-recurring. Please clarify and/or revise to remove reference to non-recurring in future filings. Reference is made to Question 102.03 of the Division’s Compliance and Disclosure Interpretations for Non-GAAP Financial Measures. Additionally, it appears that you have made certain non-cash adjustments to arrive at AFFO, a performance measure. Please tell us the nature of these adjustments, why the exclusion of these amounts is beneficial to investors, and why you have not adjusted for the cash portion of similar expenses.

Some comments asserted that the labeling of certain metrics is unclear or misleading:

FFO and Normalized FFO, page 44
2. We note that your calculation of FFO starts with Net income attributable to common stockholders and as such, it appears that the resulting amount of FFO represents FFO attributable to common stockholders rather than FFO for the entire company. In future filings please re-label “Funds from operations” to “Funds from operations attributable to common stockholders”.

Given the large number of reconciling items and the widespread use of non-GAAP metrics used by REITs, we would not be surprised to see additional SEC comments issued in the future. It is yet to be seen whether any material changes would be made to the use of non-GAAP metrics as a result of SEC review.

As mentioned in the NYT article, some investors may care less about non-GAAP than they do about short-term consensus estimates. Yet, it is clear that large discrepancies between GAAP and non-GAAP can often include expenses that cannot be ignored in the long run, or indications of complexity in the company’s accounting.

Note 1: Audit Analytics used NAICS Code 525930 for the REIT classification
Note 2: We classified FFO as a non-GAAP metric, in accordance with the SEC’s classification.
Note 3: The analysis is based on quarterly values disclosed in 8-K Item 2.02 for S&P 500 companies, filed between July 21, 2015 and August 4, 2015. For additional information on non-GAAP metrics, contact

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