REITs have a board of directors elected by its shareholders. Typically, these directors are real estate professionals who are highly respected in the field. They are responsible for selecting the REIT's investments and hiring the management team, which then handles day-to-day operations.
REITs earn money from rented space or sales of property. The preferred method for measuring REIT earnings is called funds from operations (FFO). The National Association of Real Estate Investment Trusts (NAREIT) defines FFO as:
Net income (computed in accordance with generally accepted accounting principles), excluding gains (or losses) from sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect funds from operations on the same basis.Basically, REITs add or deduct from net income (rent and sales computed according to generally accepted accounting principles [GAAP]) any gains or losses due to depreciation, sale of property and unconsolidated partnerships and joint ventures. Essentially, FFO measures a REIT's operating cash flow produced by its properties, less administrative and financing costs.
Under generally accepted accounting principles, net income typically assumes that the value of assets goes down over time -- somewhat predictably. Real estate generally retains or even increases in value. On the balance sheet under GAAP, however, land remains at its historical cost and buildings gradually depreciate to zero. Since a REIT's primary business involves real estate, the depreciation charges negatively skewed the company's true profitability. FFO was adopted to address that problem by excluding depreciation costs from the net income figure.
FFO is not a foolproof measure, however. Not all REITs calculate it according to the NAREIT definition and items such as maintenance, repairs and other recurring capital expenses are missing from the formula. In order to get a true FFO, investors must often read a company's quarterly report, and any supplemental disclosures.