Real Estate Investment Trusts Essay, Research Paper

Derrick Robicheaux

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Accounting for REITs

A existent estate investing trust, or REIT, is a company that buys, develops, manages and sells existent estate assets. There are three types of REITs ; they are equity REITs, mortgage REITs, and intercrossed REITs. An equity REIT is a corporation that purchases, owns and manages existent estate belongingss ; it does non have or arise existent estate loans. It may besides develop belongingss. A mortgage REIT is a corporation that purchases, owns and manages existent estate loans ; it does non ain existent estate belongingss. It may or may non arise commercial and/or residential loans. A intercrossed REIT is a corporation that purchases, owns and manages both existent estate loans and existent estate belongingss. It has the qualities of both an equity and mortgage REIT which is why it is referred to as a loanblend. One of the most distinguishing features of a REIT is that they are required to administer at least 95 % of nonexempt income to stockholders. REITs allow participants to put in a professionally-managed portfolio of existent estate assets. This is of import because anterior to Congress & # 8217 ; s creative activity of REITs merely highly rich persons were able to profit from ventures in the existent estate market. By pooling assets together in a mode similar to that of a common fund, REITs allow the mundane investor the opportunity to put in existent estate belongingss. The chief benefit of a REIT is that it is exempt from dual revenue enhancement. The normal corporation is taxed on net incomes, and so when dividends are paid, the single having the dividend is taxed. REITs can subtract dividends distributed from nonexempt income. This consequences in merely one degree of revenue enhancement. The chief disadvantage of a REIT is that since about all net incomes are distributed as dividends, the trust must happen capital to reinvest into the concern from other countries. These financess are normally raised by investings in the market, and through the capital additions realized from the sale of the REITs assets.

The 2nd method by which REITs procure capital to reinvest into the concern raises an accounting issue sing the categorization of assets. Presently, the edifices and belongings that REITs use to raise income are classified as belongings, works, and equipment. However, it can be argued that these assets should be classified as stock list. The accounting definition of belongings, works, and equipment specifies those belongingss of a lasting nature used in the regular operations of the concern. These assets consist of physical belongings such as land, edifices, machinery, furniture, tools and blowing resources. With the exclusion of land, most assets are either depreciable ( such as edifices ) or consumable ( such as forests ) . These belongingss do moderately fall into this class, particularly in the instances where the REIT is involved in pull offing the belongings and receives gross from rents. The definition for stock list relates to plus points held for sale in the ordinary class of concern or goods that will be used or consumed in the production of goods to be sold. It can besides be moderately justified that these assets fall into this class, this is the nature of REITs, to purchase and sell existent estate. This is a grey country in which sensible

people can differ. It is my sentiment that these assets should be classified harmonizing the company’s honest purpose for its usage. Many REITs ain and operate flat composites and have no purpose to sell the belongings, but are content to pull off the units and cod rent. In these types of instances the belongings is non being sold but leased. Therefore, PP & E would be the appropriate categorization, similar to the method that auto lease bureaus use. But, if the company intends to better and sell the belongings so the belongings should be stock list. This method would be similar to method by which securities investings are accounted for. Depending on the company’s purpose, securities can be classified as held-to-maturity, available for sale, or marketable securities.

Since all these belongingss are presently classified as belongings, works, and equipment, the issue of depreciation becomes of import. If these belongingss were classified as stock list, so all care and fixs would expensed as incurred, and no depreciation would be recognized. However, as belongings, works, and equipment, care and fixs would be capitalized and depreciation would be recognized over the life of the plus. This has a dramatic consequence on the balance sheet, and the bottom line. Another issue is the just representation of the fiscal state of affairs of the company. If these assets are depreciated, so it implies that their value is traveling down over clip. This is non instance with these belongingss, the market value fluctuates and many times goes up instead than down. Therefore, a batch of value is lost from the balance sheet and investors can non do an informed determination about where to put. To battle all of these issues, a figure referred to as financess from operations, or FFO, has been derived to better value REITs. FFO is calculated by get downing with net income and adding back the appropriate depreciation and amortisation figures. It would non be right to add back depreciation and amortisation that is non applicable to the specific assets in inquiry. Next the consequence of non-recurring points is added back, this does non include extraordinary points, accounting alterations, or discontinued operations. These computations constitute FFO. Although, many trusts report both FFO and net income, it is normally FFO that that is used in EPS computation. This is advantageous for the REIT because FFO is higher than net income. Therefore, EPS is higher, and in bend more attractive to investors. Those within the industry believe that these figures are a much better index of company public presentation than traditional EPS. Like EPS, P/E ratios are besides calculated utilizing FFO. Since net incomes are reported higher, so the P/E multiple comes out to be lower. This besides makes the company more attractive because it seems undervalued.

Accounting consists of a complex set of regulations and guidelines that do an exceeding occupation of reasonably stand foring the huge bulk of corporations in the market place. However, there are some types of companies that are hurt by traditional accounting methods due to the alone nature of their concern. It is just to do an exclusion for these companies sometimes because of the wide intent of accounting. This is to present seasonably, and accurate information to investors so that they may do informed determinations about how to apportion resources.

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