Review of Accounting Studies, 3, 103–130 (1998)
1998 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.
An Empirical Evaluation of the Usefulness of
Non-GAAP Accounting Measures in the Real Estate
Investment Trust Industry
THOMAS D. FIELDS
J. L. Kellogg Graduate School of Management, Northwestern University, Evanston IL 60208-2002
University of California-Davis, Davis, CA 95616-8609
S. RAMU THIAGARAJAN
J. L. Kellogg Graduate School of Management, Northwestern University, Evanston, IL 60208-2002
Abstract. We conduct three sets of analyses to compare the usefulness of net income, based on generally accepted
accounting principals (GAAP), and the industry-advanced funds from operations (FFO) in the context of the real
estate investment trust (REIT) industry. In our ﬁrst set of tests, we ﬁnd that FFO is more strongly associated with
one-year ahead FFO and one-year ahead operating cash ﬂows than is net income. Conversely, we ﬁnd that net
income explains more variation in one-year ahead net income and current stock price than does FFO. Second, in
support of the claim that some REITs manipulate FFO, we document that young REITs and REITs that are likely
to access capital markets are more likely to manage FFO. Third, we ﬁnd that, for a sample of ﬁrms that disclose
current value information, both net income and FFO fail to reﬂect holding gains or losses on unsold properties in
a timely manner. Overall, our analyses suggest that the REIT industry’s claim that FFO is more useful than net
income is premature because the superiority of one measure over the other is highly contextual.
Forseveral years, real estate investmenttrusts (REITs) and security analysts have questioned
the usefulness of net income for investors’ decisions (Edmunds, 1982; National Association
of Real Estate Investment Trusts (NAREIT), 1991).
Under current generally accepted
accounting principles (GAAP), net income is calculated under the assumption that the
values of income-producing properties, the principal assets of REITs, diminish over time.
Consequently, net income does not reﬂect holding gains on unsold properties. Additionally,
it includes a periodic charge for depreciation even for properties that have appreciated.
Because real estate values have risen considerably in certain years, the non-recognition of
unrealized holding gains together with inclusion of a depreciation charge has caused net
income to understate proﬁtability in these years. Further, because the depreciation charge
reduces the reported book value of properties on the balance sheet, historical cost book value
has been criticized as a poor measure of the economic worth of these properties (Arnold
and Goscicki, 1995; Zani, 1993).
The concerns with net income and book value have led
industry analysts and real estate ﬁrms to allege that the historical cost model has impaired
the ability of investors to value real estate ﬁrms and hence reduced these ﬁrms’ access to
capital markets (Brenner, 1984, p. 34; Tishman Realty & Construction Co. Prospectus,
1977, p. 68).