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Shopping Centers Today -> October 2001
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WILL EPS BECOME THE NEW REIT METRIC?
By Donna Mitchell
When three Wall Street firms said they would adopt a single method for calculating earnings per share (EPS) for REITs, it underscored debate over whether EPS or funds from operations (FFO), the industry standard, is a more accurate way to evaluate the publicly owned shopping center firms.
REIT equity analysts from Salomon Smith Barney, Morgan Stanley and Merrill Lynch jointly announced in July that they would include EPS estimates in REIT research reports along with FFO. Going forward, the three firms will use a consistent method for calculating EPS, and publish it in their research reports.
Gary Boston, a Salomon Smith Barney REIT analyst, said the need for one EPS standard was clear, especially after seeing inconsistencies on Thomson/First Call, a depository for analyst earnings estimates for public companies.
“Because EPS is a new concept for the REITs, there were a variety of versions of EPS being submitted,” he said. “Thomson/First Call did not establish guidelines for reporting those figures.”
Lawrence Raiman, who heads Credit Suisse First Boston’s REIT equity research team, was in talks with other sell-side analysts to potentially create a unified EPS definition. Raiman said analysts “may report EPS differently now that the investment community will start looking at it more closely than they previously were.”
The trouble with FFO, analysts say, is that it reinserts property depreciation expenses, which are not added back into EPS. The supplemental measure adjusted funds from operation (AFFO) sometimes includes figures for capital expenditures on property, but there is no industry standard for doing that, said Boston. Secondly, FFO is not approved by the SEC, and falls outside of generally accepted accounting principles.
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More important, REITs have always reported EPS figures to the SEC. But retail REIT officials cherish FFO, and point out some flaws with EPS. Depreciation is based on a sometimes-rigid formula that doesn’t respond to the nuances of real estate markets, said Barbara Baker, vice president of investor relations for Taubman Centers, Bloomfield Hills, Mich. FFO figures are a tool more suitable for reflecting the goings-on of the real estate business.
Supporting the argument for including EPS is that REITs may be added to the S&P 500 Index, which is comprised of representative samples of U.S. companies across major industries. Reporting EPS will allow REITs to correspond in familiar terms with investors who use the index as their benchmark.
The index is regarded as an indispensable tool for all types of investors, and a REIT niche would give the companies exposure to a broader investor base — and more sources of cash. At press time, Elliott Shurgin, vice president of index services at Standard & Poor’s, New York, City, who is also a member of the S&P index committee, said a decision about REITs’ inclusion was expected by late September.
“There is no cookie-cutter way of doing it,” Baker said. “The analyst has to go through financial statements to understand the value of the assets.” Baker also downplayed any EPS role in getting REITs into the S&P 500, saying that if they are included in the index, it will be because of their legitimacy and maturity as an industry.
Further, the three Wall Street analysts say, EPS figures can be a bit skewed. If a REIT sells a particularly large portion of its assets, then those gains might appear divergent when considering the company’s activities over the whole year.
Bernie Freibaum, CFO of General Growth Properties, acknowledged some benefits to using EPS.
“I think anything that enhances your investor base is a good thing,” Freibaum said, yet noted, “there is no use fighting an uphill battle with FFO. If other industries can use alternative measures of operating performance, then we should be able to do the same thing.”
Admittedly, EPS depreciation calculations can be overly conservative, according to Matthew Ostrower, a Morgan Stanley REIT analyst. But the fact remains that “it is an audited measure which we believe is fairly consistent from company to company. Many investors out there invest based on quantitative analysis. They input a set of numbers and out pops a result. This gives them another option.”
Also, there is talk of depreciating various portions of a property over different periods of time, rather than depreciating the entire property for the standard 30 to 40 years, said Boston. Called component depreciation, the process could be adopted as an accounting standard, taking EPS another step toward being a valuable metric for REITs.
The Retail REIT Index was designed by Salomon Smith Barney for Shopping Centers Today. The index is based on total returns (including dividends) starting at a base of 100 on December 31, 1995. For the period ending Aug. 31, the regional mall index is at 205.18, up 3.8%; the strip center index (including power, neighborhood and community centers) is at 196.91, up 4.5%; and the factory outlet index is at 139.66, up 4.3%. The index is updated monthly. |
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