REIT Accounting It’s an Art Not a Science

1. REIT Accounting It’s an Art Not a Science

2. Carl T. Berquist • Deputy Director of Arthur Andersen (AA) Real Estate and Hospitality Services Group (REHSG) Worldwide • Head of AA Southeastern U.S. REHSG and Metropolitan Wash., D. C. REHSG Practice • National Association of Real Estate Investment Trusts (NAREIT) - Associate Board Member

3. Carl T. Berquist • Experience • Initial and Secondary Public Offerings • Assisting in various private real estate capital raises • Financial modeling, projections, strategic planning

4. Overview • REITs • Market Performance Indicators • FFO • AFFO • FAD • EBITDA • Debt to Market Cap • Performance Analysis • Application of Accounting Policies

5. Real Estate Investment Trust (REIT) • Assets are primarily composed of real estate held for the long term • Income mainly derived from real estate • Pays out at least 95 percent of taxable income to shareholders • One level of taxation • Mutual fund for real estate

6. REIT Rules Income Tests Asset Tests Widely Held 95% DistributionRequirement

7. 15 33 168 How Many REITs Are There? • Over 300 U.S. REITs, 216 Publicly Traded

8. Annual Total REIT Security Offerings $ Billions

9. Year-end Market Capitalization $ Billions

10. REIT Advantages and Disadvantages Advantages • No corporate income taxes paid • Liquidity and access to capital • Public market pricing • Expert management • Strong institutional investor interest • Growth opportunities • Lower debt levels • Corporate governance • Independent analyst review • Attractive returns Disadvantages • Paying out 95%+ of net income reduces internal capital for growth • Pay-out requirements force dependence on healthy capital markets • Operating businesses must be owned and operated outside of the REIT • Being placed into “REIT Box” limits potential investor universe • Market expectations limit leverage • GAAP accounting issues

11. Dissecting the REIT Income Statement Revenues XXXX Operating Expenses (XXX) EBITDA XXX Interest Expense (XX) Funds From Operations XXX Depreciation & Other (XXX) Net Income XXX Debt Principal Amortization (XX) Normalized Cap Exp (XX) Tenant Improvements (XX) Depreciation & Other XXX Funds Available for Distribution XX

12. Funds From Operations (FFO) • Net income (GAAP) excluding gains (or losses) from debt restructuring and sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures

13. Evolution of FFO • NAREIT white paper • Net income not a satisfactory measure • Conventional P/E multiples not meaningful • FFO/Share equivalent to EPS • Definition varied in practice • Key benchmark statistic • Used to compare to peers

14. Key FFO Measurement Benchmarks • Growth Rates • Payout Ratios (Dividends/FFO) • FFO Multiples

15. Growth Rates • Done on a Per Share Basis • Compared to Peers • Quality of Earnings • Core vs. Accounting Gimmicks • Accretive Acquisitions

16. Payout Ratios • Safety of Dividend • Retained Captial

17. FFO Multiples • Similar to PE Ratio • Drives Share Price • Share Price/FF0 per Share = Multiple • The Industry Average is 10 - 12 Times • Several Subjective Variables • Management • Business Strategy • Leverage • Quality of Earnings • Dividend Growth • Payout Ratio

18. Maximum price a REIT can pay for $10 million in FFO and not be dilutive

19. Adjusted Funds From Operations (AFFO) • FFO adjusted for straight-lining of rents, as well as a reserve for recurring capital expenditures (including tenant improvements) • Similar to FAD

20. Funds Available for Distribution (FAD) • Another Type of Payout Ratio • Dividend / FAD • Highlights Safety of Dividend • Shows Ability to Grow Dividend • The Lower the %, the Greater the Ability to Grow • More than 100% Shows the Dividend Cannot be Sustained

21. Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) • EBITDA/Interest Coverage • Ignores capital structure • The higher the ratio the greater the ability to grow • Can always purchase EBITDA

22. Debt to Market Capitalization • Total Debt / (Debt + Equity Capitalization) • The Lower the Ratio, the Greater the Ability to Grow • Acquisitions can be leveraged • Expansions can be financed • Reduced Refinancing Risk

23. Stock Price • Quality Earnings • Growing FFO • Strong Management • Well Defined Growth Strategy • Low Debt to Market Cap • Ability to Execute

24. Accounting “Gimmicks” • Capitalization vs. expense • Straight-lining of rental revenue • Tenant improvement costs vs. rental rates • Off balance sheet financing • Off balance sheet ventures • One time transactions • FFO adjustments • deferred finance fees • percentage rent • preferred returns • unusual items

25. Clarkson • Acquisition reserves • Leverage (Mark-to-Market) • FAD pay out ratio

26. Clarkson • “The company continued its innovative policy of renovating apartments to fit specific tenant needs and notes that this is a growing source of revenue for the future.”

27. States • Tenant improvements • Income from joint ventures • Internal development costs • Straight-lining of rents

28. American • Reserves • Other adjustment

29. Performance Indicators

30. American

31. States

32. Clarkson

33. REIT Accounting Its an ArtNot a Science • Summary • There is no easy answer • Understand the numbers • Research is critical