What it means
The name originally stood for the National Association of Real Estate Investment Trusts, and today the organisation uses the shortened form Nareit. It was founded in 1960, the same year that US legislation created REITs as a way for ordinary investors to own a share of commercial property.
It represents REITs, their advisors and service providers, and it lobbies on tax and regulatory matters. The association also produces research and index data that investors use to track the sector.
Indexes based on REIT shares are often used as benchmarks by fund managers, in the same way that equity indexes are used for company shares. Its most practical contribution for finance readers is the definition of funds from operations, or FFO.
Net income is a poor guide to a property company's performance because accounting rules deduct depreciation on buildings even when the buildings are rising in value. FFO adjusts for this by adding depreciation back and removing one-off gains from property sales.
Analysts use FFO per share to compare REITs, and to work out valuation measures such as the price-to-FFO multiple. Many REITs also report an adjusted version, which can differ from the Nareit definition, so it is important to check which measure is being quoted.
For non-specialists, the main lesson is that a REIT's profit as shown in the income statement can look very different from its cash-generating ability. NAREIT's standard definition gives everyone a common starting point.
REIT rules also explain why the sector matters to income investors. In most regimes a REIT must pay out a large share of its taxable income as dividends, which is why REIT shares often have higher dividend yields than ordinary shares but less retained cash to fund growth.
In practice
Real-world examples.
Example
An equity analyst compares two apartment REITs. Because one sold a large building during the year and reported a big accounting gain, she uses FFO rather than net income to compare their underlying performance. Her note to clients explains the adjustment in two plain sentences.
Example
A pension fund trustee wants exposure to commercial property without buying buildings directly. He uses a REIT index published by Nareit as the benchmark for the fund's listed property allocation. Each quarter the trustees compare the fund's return with that benchmark.
Example
A small manager of self-storage facilities considers converting into a REIT. Its lawyers consult the association's guidance on the rules for income distribution and the reporting measures investors will expect. The board learns that it will need to publish FFO figures from its first year as a listed company.
Formula
Calculation
FFO = Net income + Real estate depreciation and amortisation - Gains on sales of property (and add back losses or impairments)
A REIT reports net income of $12,000,000, real estate depreciation of $8,000,000 and a one-off gain from selling a building of $3,000,000.
FFO = $12,000,000 + $8,000,000 - $3,000,000 = $17,000,000. With 10,000,000 shares outstanding, FFO per share is $17,000,000 / 10,000,000 = $1.70.Case study
Seen in the real world.
Lakeshore Retail Trust is an illustrative, fictional REIT that owns shopping centres. In one year it sold a mall for a large gain, and its reported earnings per share doubled compared with the prior year.
The investor relations team knew this would mislead shareholders, so it also published FFO per share under the Nareit definition. FFO rose only 3%, which more accurately reflected rents and occupancy.
In this illustrative story the share price barely moved, because analysts looked through the one-off gain. Management also included a short reconciliation table showing each step from net income to FFO. The case shows why a standard FFO definition exists: it stops accounting quirks from distorting the picture.
Watch out
Common mistakes.
- Assuming FFO is the same as cash flow, when it still excludes items such as the ongoing spending needed to maintain buildings.
- Comparing a Nareit FFO figure with a company's own adjusted FFO as if they were identical.
- Treating Nareit as a regulator, when it is a trade association that represents the industry and does not enforce the rules.
Questions
People also ask.
What does NAREIT stand for?
It stood for the National Association of Real Estate Investment Trusts and is now commonly written as Nareit.
Why is FFO used instead of net income?
Because depreciation on property is a non-cash charge that can understate the property company's real earning power. Property values often rise over time even as the accounting value of the building falls.
Is NAREIT only for US companies?
Its membership is mainly US-based, although it works with international REIT bodies and many countries have equivalent regimes. Tax and distribution rules differ from country to country.
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