The Value Relevance of Non-GAAP Earnings: The Case of EPRA Earnings for European Real Estate Investment Trusts (REITS)

Abstract

The vast majority of European Real Estate Investment Trusts (REIT) choose, under IAS 40, to report fair value of investment properties on the balance sheet and therefore recognize changes in fair value in a gain or loss in the income statement. Under European Public Real Estate Association (EPRA) guidelines, most REITs report a non-Generally Accepted Accounting Principles (GAAP) measure of recurring performance — EPRA earnings — in addition to International Financial Reporting Standards (IFRS) financial statements. EPRA proposed these adjustments to IFRS earnings to neutralize transitory items such as changes in fair value, calculate core operating results more accurately, and indicate the extent to which earnings can support dividend payments. Based on studies suggesting that earnings without the transitory items are more useful for investors, we assume that EPRA earnings are more value relevant than IFRS earnings. Using a sample of 680 company-years over the period 2011–2017, we find that market value capitalizes EPRA earnings more than twice as much as IFRS earnings. We also find that changes in fair value of investment properties provide additional information for the valuation of REITs, supporting the idea that the dis-aggregation of the net income into recurring earnings and transitory items can be useful to investors. Finally, our results show that EPRA earnings are not always more value relevant than other non-GAAP indicators sometimes used by REITs to measure their recurring performance, such as Funds from Operations. Moreover, a complementary analysis suggests that the choice of EPRA earnings to communicate recurring performance is independent of the economic characteristics of REITs and is mainly made by EPRA member companies.