While REITs are required to distribute 90 percent of their taxable income as dividends to shareholders, they tend to distribute more dividends than required. Their dividend policy is often related to cash flow, leverage, and firm size. To clarify dividend policy, management often supplements the financial statements with non-GAAP performance measures, aiming to provide additional resources beyond GAAP earnings to estimate future dividends.
National Association of Real Estate Investment Trusts (NAREIT) defines Funds From Operations (FFO) as net income, excluding gains or losses and depreciation. An adjustment for unconsolidated partnerships and joint-ventures is deducted as well. Since the introduction of the definition in 1991, the term has come to be widely used by the industry. The intent behind the voluntary performance measure is to remove from earnings the effect of depreciation, which reduces the value of real estate over time.
FFO is more helpful compared to reported earnings in explaining the dividend policy of Real Estate Investment Trusts (REITs), notes Danny Ben-Shahar of the Technion, Israel Institute of Technology. He extracted a data set of 590 REITs over the period 2001 and 2008. He concluded that indeed FFO is helpful to understand dividend policy. And that the depreciation component affects the ability to predict the distribution of dividends.