Asked where to lay the blame for the continuing malaise in the real estate sector, both analysts and investors agree that one of the main causes remains self-interest.
"So many REIT managers are used to running the show their way as private companies," says Craig Silvers, head of REIT research at
Sutro & Company
and a member of
. "Sometimes they just don't think about what even the perception of conflicts can do to investor confidence."
How to address that credibility gap was a major concern for the participants in the latest gathering of the Roundtable, which took place during the annual
Convention in Beverly Hills, Calif. With real estate shares remaining in the red for the year -- the
SNL Securities Equity REIT Index
is down 5.9% year-to-date, and that's after factoring in a hefty 8.5% dividend -- the industry has been groping for
ways to end its multiyear slump.
Unfortunately, examples of self-dealing are entirely too easy to find. Robert Steers of
Cohen & Steers Capital Management
shared with the NAREIT audience a list of two dozen REITs, or real estate investment trusts, that have recently completed related-party transactions. These include REITs which bought or sold assets between a company and its officers and/or directors, or companies which extended loans to insiders. These activities undermine confidence in all aspects of a company's operations. "There is a credibility gap between how these issues are handled and the way shareholders perceive them," says Steers, adding history is not on REITs' side. "The industry has a poor track record as to how they address these issues."
The lack of credibility results directly in a lack of capital flowing into REITs. "It is in the REITs' long-term economic interest to
eliminate conflicts and change investors' perceptions," says Nori Gerardo-Lietz, a Detroit-based adviser to institutional investors and pension funds. "If you want to attract broad-based institutional interest in the industry, you have to act like an institution."
Along with the examples cited by Steers, she cites the lack of independence on REIT governing boards and the perceived indifference of REITs toward large, institutional investors. "The cold, hard truth is the composition of REIT boards needs to change to become more diverse, independent and active," she says. "If you want to change the perception that this industry is a specialized subset that attracts only real estate capital, you have to reach out and get to know what mainstream institutional investors want."
Equally important to buyside investors are the issues of inadequate accounting standards and the lack of reporting and disclosure consistency among REITs. Because real estate depreciation expense distorts traditional net income as calculated under generally accepted accounting principles, or GAAP, REITs' financial health is usually measured by Funds from Operations, or FFO. That measure adds depreciation back to earnings, and excludes capital gains and losses from property sales to provide a better measure of a REIT's operating performance.
Problem is, FFO is not an audited number and, hence, can be
"managed" by companies to provide a less-than-candid financial picture. "The problem with FFO is that nobody is sure what it means. It is not especially useful in comparing companies in the sector," says Roundtable member Marc Halle of
Prudential Real Estate Securities
NAREIT has been working to standardize FFO reporting and was hoping to establish clear standards for reporting for release at the annual meeting. Instead, the accounting committee only offered a position that nonrecurring expenses should be included in FFO calculations, which falls far short of moving FFO more toward GAAP standards.
That failure is discouraging to both analysts and some REIT executives who feel penalized by the lack of uniformity and accountability in financial standards. "FFO is a meaningless number," says Douglas Crocker, President and CEO of
Equity Residential Properties Trust
. "I'm very disappointed that the REIT industry did not take a step to move closer to GAAP."
Combine the accounting issues with other conflicts and REITs retain their appearance as risky ventures to many outsiders. Says Gerardo-Lietz, "If
REITs want to be in corporate America, they need to look like it."
Coming Tuesday in Part 2: Predictions for the next six months' performance and our experts' picks of the most promising REITs.
Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback at