A Preliminary Analysis for Measuring Operating Performance of Real Estate Investment Trusts in Taiwan: Net Income vs. Operation Funds

Abstract

The National Association of Real Estate Investment Trust (NAREIT) has suggested that Net Income (NI) might not be the best measure of operating performance for income-producing real estate, since depreciation measurement based on historical cost is inappropriate for income-producing real estate. Thus, the NAREIT purposes Funds From Operation (FFO) as a supplemental measure for operating performance of income-producing real estate. In Taiwan, Real Estate Investment Trusts (REITs) are a relatively new type of income-producing real estate investment. Since the data on REITs in Taiwan is not yet sufficient, this work uses hotel, tourism and department store industries, or real estate operating firms (REOCs), as a proxy for a preliminary study of REITs in Taiwan. The empirical results show that using a model incorporating both NI and FFO understates the explanatory power of two variables, since multicollinearity occurs. Therefore, the current study separately estimates the information content of NI and FFO, finding that the explanatory power of NI is higher than that of FFO, though the forecasting ability of FFO is higher than that of NI. But the differences between the explanatory power and forecasting ability of NI and FFO are very small. The results show that NI and FFO are both informative for income-producing real estate in Taiwan. Keywords: Net Income, Fund From Operation, Real Estate Investment Trusts