Funds from Operations versus Net Income: Examiningthe Dividend Relevance of REIT Performance Measures

Abstract

This study compares Funds From Operations (FFO) and netincome by examining how well these two performance measuresexplain the dividend policy of Real Estate Investment Trusts(REITs) beyond operating cash flows. The findings reveal thatwhile the non-cash component that is common to both FFO andnet income is significantly associated with the level of dividendsdistributed by REITs, the additional non-cash component in netincome but not in FFO has no association with dividends. Thefindings also show that the non-cash component in net incomebecomes significantly associated with dividends only whenmeasurement errors in depreciation are low (i.e., reportingquality in depreciation is high). By suggesting that the inclusionof depreciation distorts the dividend-relevance of REIT netincome, this paper provides further support to the dominance ofFFO over net income for financial reporting in the REIT industry.