By Darlene Bremer

Misstated earnings. Inflated profits. Arthur Andersen. Enron. The very thought of these phrases sends shivers down investors' spines and causes corporate financial officers' hair to stand on end. The recurring cases of corporate improprieties have shone a spotlight on the financial disclosure practices of all public companies, including REITs. And although the Securities and Exchange Commission (SEC) mandates many aspects of financial disclosure, the focus has been mainly on ensuring companies provide enough information.

However, there are differing opinions among REIT executives, analysts and investors as to whether the greater problem lies in the amount of information being disclosed or the quality of what is available. Some investors would rather have access to a company's entire slate of financial data to be able to analyze what they see as relevant in making their specific investment decisions and have some level of confidence that nothing of substance is being withheld. On the flip side, other investors would rather see a company concentrate on providing the most essential information in a well-organized format.

However, trying to define what information is essential–especially in light of people's apprehensions regarding the recent spate of corporate scandals—is open to interpretation, and might be a cause for the information overload some investors face.

"Generally, producing more information is better," says Ralph Block, chief REIT portfolio manager at Bay Isle Financial Corporation. But Block adds that the real problem isn't the amount of information, but trying to discern what information is most useful. "A lot of analysts feel they have to get as much information as possible from the company, creating a situation where much of it is not relevant beyond examining short-term stock fluctuations."

Mark Blackburn, portfolio manager at INVESCO Realty Advisors, agrees that more information in financial disclosure is better than less, but that it must be usable and relevant to the investor. "There's a delicate balance between publishing voluminous management reports that summarize business performance and providing an appropriate amount of relevant information that investors can use in analyzing a company's stock and making company-relative investment decisions," he explains.

According to analyst firms, more information for its own sake is not what analysts and investors want. "What is needed is information that is appropriately interpreted by the REIT and presented in a useable form, and that allows analysts and investors to interpret trends and understand the REITs' businesses better," says Gregory Whyte, managing director at Morgan Stanley.

To some, however, all information is relevant. According to Steven Brown, managing director at Neuberger Berman, LLC, a large quantity of information better enables investors to analyze a company and make an informed investment decision. "An investor is focused on the quality of a company's earnings and financial disclosure information helps him or her determine the accuracy of the company's earning potential," he says.

From the REIT's viewpoint, the debate on quantity vs. quality focuses on the company's need to provide the information that will help attract and retain investors. A survey of REIT investor relations professionals conducted by Real Estate Portfolio showed that the majority of those surveyed believed there is already enough information being provided, and what improvements can be made should be focused on improving the quality and presentation of that data.

"The key debate is not really about how much information should be provided, but what information is more useful," says Mike Pappagallo, chief financial officer at Kimco Realty Corporation (NYSE: KIM). And if the process of providing that information occasionally takes away from the REIT's core functions, that is accepted because disclosure is viewed as an integral part of communicating how well the company is doing to potential investors, Pappagallo says.

A similar sentiment is shared at Equity One, Inc. (NYSE: EQY), which sees financial disclosure as an integral part of communicating with the investment community. "The issue is not quantity, per se, but providing relevant, usable information that enables members of the investment community to make well-informed decisions," says Howard Sipzner, CFO at Equity One.

However, according to Steve Sterrett, CFO for Simon Property Group (NYSE: SPG), concise, relevant, brief information is best. "Analysts and investors are examining the financial information REITs provide to better understand how each company is performing relative to the others. If the financial information is disclosed more concisely, they are able to do their jobs more efficiently and effectively," he says.

Can providing all this information, however, still be considered beneficial to the REIT if it detracts from the company's ability to perform its core function? "Providing extensive financial disclosure information may indeed take away from the company's core function, but to most REITs, financial disclosure processes are something they've been doing all along and are just considered a cost of doing business," observes Jahn Brodwin, partner at Schonbraun, Safris, McCann, Bekritsky & Co., a consulting and accounting firm that specializes in real estate.

What Are Investors Looking For?

Given that some investors think quality is king and others want as much information as possible, is there a consensus as to what financial data is deemed essential when evaluating a publicly traded real estate company? Generally, investors are looking for data that will enable them to assess whether the REIT's performance is improving or deteriorating, that offers consistency of comparable information among REITs, and that provides more explanations of how specific numbers are derived.

"At the highest level," Pappagallo adds, "investors are looking for enough information to understand the sources and compositions of earnings numbers to determine the predictability and quality of those earnings." Overall, different investors require different levels of details. According to Pappagallo, some investors want summaries of trends and an explanation of the composition of earnings, while others want to use the information provided by financial disclosure documents to develop complex financial models from which to determine a company's value.

Key performance measures that investors want information about include sales and occupancy levels, leasing spreads, and the weighted cost of capital. "Investors are also looking for an understanding of the trends that drive those numbers, as well as explanations and analyses of unusual or nonrecurring events that are influencing the numbers so that they can develop a complete snapshot of company performance," Sterrett says.

As an investor, one of the aspects of financial information that Block is examining is comparable store results. "For example, how did a REIT's properties perform during the same period last year." he says. Block also believes it would be useful for investors to receive better disclosure about capital expenditures, such as tenant improvements or the replacement of roofs or driveways.

Another key point in analyzing a company is seeing how the items in a REIT's income statements were derived, Brown says. "It's important in assessing a REIT's performance to understand the source of the numbers," he says, adding that investor supplemental packages, that generally accompany earnings releases, can be a good source of that kind of information.

Although investors in different sectors of the real estate market do not require different levels of information, they could require different types of data. "For instance, investors in retail REITs might focus more on the health of the retailers, rather than on the REIT itself, while those investors involved in office REITs require information that helps them understand how much sublease space is available versus primary lease holdings," says Brodwin.

Whyte agrees that REITs that operate in different sectors need to provide investors and analysts with different types of information. "For example, analysts of office sector REITs want to see information about leasing commissions and what levels of tenant improvement costs are being expended to attract new tenants."

Uncovering the Quality in the Numbers

Regardless of how much financial disclosure information is provided, investors may be best served uncovering the quality of what is provided by focusing on certain key metrics. "Investors need to focus on results in the current quarter as compared to the same time period in the previous year," Block advises. He also suggests that investors examine the returns REITs are generating on their investments, as well as whether there is a significant amount of non-rental income being generated, which, he explains, is usually less valuable than rental revenue. "To determine the value of a REIT's stock, investors should also scrutinize financial disclosure information to see how much money is being spent on capital expenditures, what the REIT's development risk is, and what the company's overhead and property expenses are," he summarizes.

Brown suggests that investors focus on the disclosed information that analyzes the underlying trends of the REIT's performance at the property level. "Supplemental package information often provides detailed information about trends in tenant improvement costs and leasing commissions, as well as trends in occupancy and rent levels for the REIT's existing portfolio," he says. In addition, Brown believes that investors should focus on off-balance sheet activities, such as joint venture developments and acquisitions, because this information provides a valuable way of evaluating the earning potential of the REIT.

"Investors should examine the REIT's long-term return on invested capital, as well as use the information provided to understand whether management has the skill and strategies to continue that growth pattern," Brown explains.

One of the unique aspects of REITs versus companies in other industries is that analysts may value REITs based on different metrics, such as (FFO) per share, because there is a higher than normal component of depreciation associated with the real estate business as opposed to other industries. "It is important for analysts and REIT investors to examine [earnings before depreciation] as opposed to just earnings because within the real estate industry, the generally accepted accounting principles (GAAP) depreciation is generally thought of as much greater than actual depreciation," Morgan Stanley's Whyte says.

Also, since REITs rely heavily on debt for growth and general health, investors need to focus on debt levels, especially mid-term debt that is due to mature two to four years out. "In addition," Brodwin adds, "investors need to watch REITs' concentrations in geographic markets, as well as in their property, tenant, and industry types."

How REITs Stack Up

So, then, are investors getting the levels and types of information they are looking for in the reams of financial disclosure documents they are receiving? "Generally, yes," says Block. The REIT industry, he adds, has significantly improved in the area of disclosure, although there is always room for improvement. "REITs could still provide more standardized, comparable information," he says. And although most investors probably do not want as much information as analysts do, Block says there is really no good way to determine what information would be equally relevant to all investors.

"The best companies are providing comprehensive portfolio data by property, by property type, and by geographic markets," Whyte says. In addition, such companies provide "decent" data about recent acquisitions and new development projects. "This information is important because it helps the investment community assess whether the company is meeting performance expectations."

In general, the consensus seems to be that most of the information investors are looking for is provided by REITs, and, according to Brodwin, provided as well as any other industry. "REITs do an excellent job of disclosing timely financial information in both their audited financial statements and in their investor packages," he says.

Blackburn goes one step further, adding that REITs do a better job of financial disclosure than most other industries in the stock market. "The problem we wrestle with is the different forms and levels of usefulness in which the information comes to us, which makes effective and efficient use of it more difficult," he says.

George Yungmann, vice president of financial standards for the National Association of Real Estate Investment Trusts (NAREIT), says that REITs provide significantly more disclosure and supplemental information than most other industries. "There is more disclosure by REITs about joint venture arrangements, more extensive information about capital expenditures, and about rents and leasing activities," he observes.

In addition, Yungmann says that NAREIT's Best Financial Practices Council provides disclosure guidance-including model disclosures. Over the past two years, the council has issued guidance covering disclosures about capital expenditures, joint ventures, income taxes and discontinued operations. The purpose of this guidance is to enhance the uniformity and effectiveness of the industry's disclosure practices.

Although financial disclosure varies from company to company, Pappagallo believes that, as a whole, REITs are indeed providing investors with the information they need. "At this juncture, most REITs prepare comprehensive supplemental packages with a substantial level of detail, enabling investors to make the assessments they need."

And that seems to be the primary difference between the amount of information normally desired by investors and by analysts. "Investors need details that are meaningful and that will allow them to make relative assessments between companies, while industry analysts tend to require more company specific detail to continually refine their analyses," Blackburn says.

Brown, however, believes that investors need the same level of information in financial disclosure as analysts. "The information is very useful in building a base of knowledge and creating an earnings model to determine the level of a company's investment attractiveness and in building confidence in that assessment," he says.

The Cost of Disclosure

In the past five years or so, the costs and time involved for providing financial disclosure information has increased, but primarily as a function of company growth.

Pappagallo estimates that disclosing the necessary financial information to investors adds about four to five days to the company's closing reporting cycle. "Since most REITs don't generally have large accounting and financial reporting staffs, the amount of time needed to prepare financial disclosure documents has increased in proportion to the increased demand for information," he says.

Equity One, for example, has one dedicated staff member to prepare filings, an outside accounting firm to audit financial statements, and an outside law firm to ensure that filings are completely compliant with regulations. "All three add up to several hundreds of thousands of dollar per year in costs," Sipzner says.

At Simon, Sterrett estimates it takes about 50 to 100 man-hours per quarter to prepare the company's supplemental information package, which, as it has become part of the normal financial reporting routine has grown easier to do in the last five years or so. "Most of the information is already in the database and generated by the system. It is mostly a matter of putting the information into an understandable format," he observes.

Room for Improvements

If the time and costs, then, are not too cumbersome, can the information that REITs provide be made more user friendly? Block believes that financial disclosure can be made more efficient by using the Internet to provide more specific information and details not included in press releases. "Receiving information through the Internet allows the investor to choose what topics to research for more specific details," he says.

Sterrett also sees the Internet as a way to make financial disclosure more user-friendly. "Some REITs are already sending this information electronically, which enables the user to sort through the data as he or she wishes," he says. He adds that for those who don't prefer to use the Internet, the supplemental packages that REITs provide quarterly are better organized than they ever have been before.

Blackburn believes that a more standardized format of reporting would make the information more user-friendly. "At the very least, using capital expenditures as an example, it would be helpful if REITs reported what they spend their money on, and how it is recorded."

Pappagallo says it may never be possible to reach the level of information standardization and comparability to satisfy all analysts and investors, primarily because of how individual companies view and analyze their own performance. It is, however, an admirable goal, he adds.

Getting Better, but Risk Will Remain

The task of the portfolio manager and investor is to use whatever information is available to assess which stocks are apt to perform better within an appropriate time frame. A lot of the financial information that is disclosed by REITs, however, is not always relevant to the long-term investment value of the stock. Unfortunately, it is difficult, if not impossible, to determine what information should be excluded during any particular economic cycle. "Much of what is disclosed may not be relevant to everyone, but all of the information will be relevant to some," Block says.

Furthermore, recent corporate scandals have contributed to the desire by some for even more financial information. "Some investors are nervous about companies hiding valuable information, particularly if it is negative," Block says.

And although recent attention and commentary on disclosure and the efforts to improve its availability and quality are commendable, no amount of information, Blackburn concludes, will eliminate the uncertainties inherent in assessing stocks.

Darlene Bremer, a frequent contributor to Real Estate Portfolio, is a freelance writer based in Solomons, MD.

Legal Requirements and the SEC There is an extensive list of required corporate filings for financial disclosure from the SEC, many of which are available through the EDGAR system at www.sec.gov. The principal document used by most public companies to disclose corporate information to shareholders is its annual report, which includes financial data, results of continuing operations, market segment information, new product plans, and subsidiary and research and development activities. A few of the other financial disclosure forms required by the SEC include: The Prospectus contains the basic business and financial information on an issuer with respect to a particular securities offering. Form 10K is the annual report that public companies file with the SEC. It provides a comprehensive overview of the business and, for 2003, must be filed 75 days after the end of the company's fiscal year. Real estate companies must list their properties and the associated cost basis and depreciation of those properties. Form 10Q is filed quarterly by most reporting companies. It includes unaudited financial statements and provides a continuing view of the company's financial position during the year, and, for 2003, is due within 45 days of the close of each of the first three quarters of the company's fiscal year. Form 8K is used to report the occurrence of any material event or corporate change that is important to investors and provides more current information on certain events than the 10K or 10Q. Schedule 14C sets the disclosure requirements for information statements. Generally, a company with securities registered under Section 12 of the 1934 Act must send an information statement to every shareholder who is entitled to vote on any matter for which the company is not soliciting proxies. SEC regulations do provide some specifics about what must be included in financial disclosure forms, but much is open to subjective interpretation. On July 30, 2002, President Bush signed the Sarbanes-Oxley Act of 2002, which contains many reforms for corporate disclosure as they apply to public companies. The Act includes: The prohibition of new loans to directors and executive officers or material changes to terms of existing loans. The requirement that CEOs and CFOs certify the accuracy of all periodic reports filed with the SEC. The requirement that, if a public company restates historical financial statements because of material noncompliance as a result of misconduct, the CEO and CFO must repay any bonuses or incentives received during the 12-month period following the first public filing of the restated financial statements. Criteria for reporting non-GAAP financial measures like FFO.