Recent REIT Results
Stoke Lively Debate

The first test of a new standard for forecasting the financial results of real-estate investment trusts has left analysts as divided as ever over how to portray the industry's earnings.

The adoption late last year of a measure called operating net income for REITs was supposed to clear up a debate over earnings that has dogged the industry and split the analyst community. Instead, it has intensified the debate.

In the wake of fourth-quarter earnings reports that were the first since analysts adopted the new forecasting standard -- which excludes gains and losses on asset sales -- some analysts are considering meeting again to redefine the measure, while others are thinking of simply abandoning it.

"Unless everyone meets to redefine it or rethink it, [operating net income] is just going to die a gentle death," says Gregory J. Whyte, an analyst at Morgan Stanley in New York, who had voted against adopting the new measure but agreed to go along with what the majority of analysts decided.

Jonathan Litt, an analyst at Salomon Smith Barney in New York, also voted against adopting the new measure but agreed to go along with the consensus. He now regrets his decision.

"Once earnings season got under way, it became apparent very quickly to us that the definition of [operating net income] the analysts had agreed upon was far too loose," says Mr. Litt, who devoted most of a recent weekly research note to the issue.

He cites industrial REITs AMB Property Corp., of San Francisco, and ProLogis Trust, of Aurora, Colo., which both engage in so-called merchant building, or developing properties for immediate sale. The two book such sales differently: AMB reports gains from merchant building, while ProLogis reports the proceeds as income. In other words, "AMB excluded these items from operating net income, while ProLogis included them, both correct under a strict reading of the definition of operating net income," says Mr. Litt.

Analysts agreed in December to use operating net income, a few months after Mr. Whyte, Mr. Litt, and Steve Sakwa of Merrill Lynch in New York decided to split with other analysts and send estimates to Thomson Financial/First Call based on a net-income figure that conforms with generally accepted accounting principles. A key goal of these efforts was to make REIT results comparable with those of other sectors of the economy that report net income. GAAP net income includes gains and losses on asset sales.

REIT analysts also continue to use a measure called funds from operations, adopted by the National Association of Real Estate Investment Trusts in 1991, that adds back depreciation from assets. But that measure has been faulted because it isn't audited, tends to overstate earnings, and isn't enforceable, which leaves it subject to a wide variety of interpretations by analysts and companies. Now the new measure, operating net income, is taking criticism that it is just as subject to interpretation as funds from operations.

Mr. Litt is hopeful analysts will reconvene and arrive at an improved definition of operating net income. "If not," he says, Salomon "may have to abandon the consensus definition and develop our own."

While analysts have talked among themselves about meeting again, no formal get-together has been scheduled.

Mr. Sakwa, who voted against adopting operating net income and who hasn't revamped his earnings models to include it, is willing to give the measure a little more time. "The industry needs at least a year to understand the nuances" of the new measure, he says. "It will take us a long time to sort of understand what it really means."

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