FFO Discussion Paper

FFO Discussion Paper

Through NAREIT, the REIT and publicly traded real estate industry has provided the definition for Funds From Operations (FFO), a supplemental benchmark to measure the operating performance of companies in our industry. This practice arose because most preparers and users of REIT and publicly traded real estate financial statements agree that net income under generally accepted accounting principles (GAAP) is not alone an appropriate or solely relevant indicator of performance or profitability. This paper discusses issues with respect to the current FFO definition and sets forth potential modifications to the measure - including a name change - for comment.

NAREIT's Best Financial Practices Council was convened in 1998 by NAREIT's Board of Governors to review REIT industry financial practices, including FFO, and to make recommendations related to how these practices could be improved in a manner providing greater clarity, consistency and credibility across the industry. Through meetings, surveys and conference calls during 1998 and 1999, the Council developed its initial viewpoints regarding FFO, the industry's supplemental performance measure. These views were presented to NAREIT leadership on March 17, 1999. Subsequently, the Council met on April 23 to further address issues raised by NAREIT's leadership. The Council's initial recommendations regarding potential modifications were presented at the NAREIT Accounting Committee Meeting on May 6, and were further presented to NAREIT's Board of Governors on June 7.

In its examination of FFO, as well as its development of initial recommendations regarding the future shape of the industry's supplemental performance measure, the Council followed several critical guideposts. Consequently, the Council sought to ensure that any modification to the industry's supplemental performance measure would:

• Generate greater acceptance of the industry by capital markets and the broader investment marketplace
• Create greater industry credibility
• Promote consistency within the industry
• Be more comparable with the performance measure used by other industries
• Act as an earnings performance measure, not a cash flow measurement
• Support attestation by independent auditors

   

  The Council evaluated a survey of industry participants conducted by NAREIT in early 1999. Consistent with this survey and the foregoing guideposts, the Council concluded that the industry's supplemental performance measure should be as close to GAAP net income as possible by including the financial impacts of both recurring and non-recurring operations. The Council also considered that, if not for the deficiencies or shortcomings associated with historical cost depreciation accounting, GAAP net income would be the appropriate performance measure. The Council also noted that the perception of many investors, as well as the media and the public, is that FFO is essentially the same as GAAP net income before accounting for real estate depreciation and amortization charges.

   

  It is the Council's hope that the discussion and steps that ensue will eventually lead to modification of the industry's supplemental performance measure to a benchmark as close to mainstream GAAP-reporting as possible - thereby serving as an "incubator" for what the industry believes should become over time an appropriate GAAP net income measure.

   

  Because the changes under discussion are potentially very significant, consideration also is being given to changing the name of the benchmark to underscore its closer connection to GAAP net income and to reach out more effectively to the broader investment marketplace. The following discussion sets forth the rationale for adjusting the industry's supplemental performance measure and the details of the changes under discussion. The three potential modifications discussed below cover:

   
• Including non-recurring items in the industry's supplemental performance measure - except for those classified as "extraordinary" under GAAP.

   

• Including gains and losses from property sales and debt restructurings in the industry's supplemental performance measure - except for those classified as "extraordinary" under GAAP.

   

• Better identifying what depreciation and/or amortization should qualify for the adjustment to GAAP net income in the calculation of the industry's supplemental performance measure.

   

  The Council encourages comment from all industry participants on all of the various aspects of these proposals, including a potential name change, the appropriate accompanying disclosures, the approach to implementing any change agreed upon (i.e., one-step or two-step), the effective date, and the prospect of restating all periods presented. The Council's current intention is to make its next-step recommendations to NAREIT's Executive Committee and Board of Governors in October 1999, but only after holding discussions and considering comments from NAREIT members and others over the coming months.

   

  NAREIT is extremely interested in the views of all REIT industry stakeholders as it makes this important decision. Please send your comments to NAREIT c/o George Yungmann, Senior Advisor, Financial Standards, 1875 Eye Street, NW, Suite 600, Washington, DC, 20006-5413. George may be reached at (202) 739-9432 and via email at gyungmann@nareit.com. Additionally, you may contact David Taube, NAREIT's Financial Standards Analyst, at (202) 739-9442 and via email at dtaube@nareit.com. You may also want to contact all or any of the co-chairs of the NAREIT Accounting Committee: Steve Richter, Weingarten Realty Investors, srichter@weingarten.com; Tim Peterson, American Real Estate Investment Corporation, tpeterson@areic.com; and Barry Lefkowitz, Mack-Cali Realty Corporation, blefkowitz@mack-cali.com. Please forward your comments no later than August 20, 1999.

   

  Background

   

  NAREIT's Board of Governors convened NAREIT's Best Financial Practices Council in 1998 with the goal of improving the quality and relevance of financial reporting for the REIT and publicly traded real estate industry. Shortly after its formation, the Council's sixteen members were asked to examine the REIT industry's supplemental performance benchmark, Funds From Operations (FFO), and to determine if a modification to the present calculation could lead to greater marketplace acceptance and industry credibility. NAREIT's leadership made this request because it determined that a critical mass of REIT industry executives, investors, analysts and auditors increasingly believe that the REIT industry's supplemental performance benchmark should be made more consistent across the industry and more comparable with the performance measure used by all other industries. This mandate from the NAREIT leadership was reinforced and supported through a survey of industry participants conducted by NAREIT in early 1999.

   

  As part of its review, the Council considered a number of factors before making its initial views known to the NAREIT leadership. The following paper provides a discussion of the Council's thinking, explains the potential modifications under consideration by the Council, and requests comments.

   

  Purpose and Name of the REIT Industry's Supplemental Performance Benchmark: FFO

   

  In 1991, NAREIT adopted a definition of FFO in order to promote an industry-wide standard measure of financial performance that would not have certain drawbacks associated with net income under generally accepted accounting principles (GAAP). The main drawback associated with GAAP net income, then and now, is historical cost depreciation accounting for real estate assets. Current GAAP depreciation practice implicitly assumes that the value of real estate assets diminishes predictably over time, while in actuality these values rise or fall with market conditions. Therefore, most industry observers believe GAAP net income requires the use of a supplemental industry measure to achieve a more complete picture of the performance of an individual real estate company or the REIT industry as a whole. FFO was created to address this need. When created, FFO also was intended to be a supplemental measure emphasizing REIT industry recurring performance that, with respect to computation, starts with GAAP net income and mainly adds back historical cost depreciation, but excludes non-recurring items. Notably, FFO was not intended to sanction deviations from GAAP net income; not to be used as a measure of cash flow; nor to signify a REIT's ability to pay a dividend. Since the introduction of the measure in 1991, and its clarification in 1995, the term has come to be widely used.

   

  Nevertheless, in recent years differences in opinion have developed as to whether the REIT industry's supplemental performance benchmark, currently named FFO, should measure the results of so-called recurring operations or whether it should approximate GAAP net income as close as possible. Measuring recurring operations involves adjustments that eliminate certain non-cash and non-recurring items, whereas an approximation for net income substantially limits adjustments and relies on GAAP for appropriate income and expense accounting. The Council weighed the merits of these two divergent approaches and determined that the REIT and publicly traded real estate industry would be served best in the long run by aligning its supplemental performance measure to GAAP net income, with only an exception to account for the deficiencies associated with historical cost depreciation. In reaching this conclusion, the Council explicitly rejected the notion that the industry's supplemental performance measure should reflect solely so-called recurring operations.

   

  During its deliberations to date, the Council has been mindful that FFO's principal purpose was to address the shortcomings of historical cost depreciation accounting. Otherwise, the Council concluded that GAAP net income would have been the appropriate performance indicator for REITs and publicly traded real estate companies. The Council also noted that many investors, as well as the media and the public, generally now think that FFO is just like GAAP net income before accounting for real estate depreciation and amortization charges. As a result, the Council concluded that the definition of the industry's supplemental performance measure should result in a calculation that matches these common understandings.

   

  Consequently, the Council has concluded that the REIT industry's supplemental performance benchmark should be changed so that it is significantly more like GAAP net income than is the case today. Moreover, the Council believes such an approach will more effectively and accurately characterize both the long-run trends and inherent volatility in the operating performance of real estate-based companies. The Council also believes that this approach should extend the use of the REIT industry's supplemental measure by the investment marketplace and provide easier comparability with non-real estate companies.

   

  Given the extent of the potential changes that follow, as well as the stated desire of NAREIT's leadership to reach out to the broader investment marketplace, the question arises as to whether the measure's name should be changed to something other than FFO. Alternatives under consideration by the Council include: "Net Income Before Depreciation;" "Earnings Before Depreciation;" and "Real Estate Earnings." In addition to seeking comments on the following potential modifications to the industry's supplemental benchmark, the Council is also interested in views about the appropriateness of a name change for the supplemental measure, regardless of whether none, any or all of the modifications discussed below are adopted.

   

  Potential Modification No. 1
  Include Non-Recurring Items in the REIT Industry's
  Supplemental Performance Benchmark

   

  For the REIT industry to more closely align its supplemental performance benchmark to GAAP net income, the Council recommends that the practice of excluding non-recurring items from the benchmark be discontinued. Although the 1995 FFO White Paper expressly permitted the exclusion of "significant, non-recurring events" from the calculation of FFO, the Council currently believes it is an unsupportable practice that is at odds with GAAP net income and in conflict with the recommended purpose of the REIT industry's supplemental measure.

   

  The Council supports this change because it believes that such a step is consistent with accounting for GAAP net income, and that the REIT industry should maintain a benchmark that is more consistent in practice and less subjective from company to company than the exclusionary practice in use today. Under this potential modification to the industry's supplemental performance benchmark, a company could not adjust GAAP net income for significant, non-recurring items, such as those associated with hedging transactions, discontinued purchase agreements, or executive severance packages. To provide consistency with GAAP, "extraordinary items" would be limited to those items defined as extraordinary by GAAP.

   

  Potential Modification No. 2
  Include Gains and Losses from Property Sales and Debt Restructurings
  in the REIT Industry's Supplemental Performance Benchmark

   

  The Council notes that a fundamental part of operating a publicly traded real estate business, including REITs, is to buy and sell property for investment purposes. Given this reality, the Council believes that the results of those transactions (i.e., gain or loss) are meaningful factors in the overall performance to be measured by the REIT industry's supplemental benchmark. In reaching this judgment, the Council is especially mindful that GAAP net income includes gains and losses from the sales of assets, and does not consider them to be extraordinary items. Consistent with the recommendation to more closely track GAAP net income, and to include non-recurring items in the REIT industry's supplemental performance benchmark, the Council believes that the recognition of gain and loss on the sale of real property assets should be included as an integral part of the REIT industry's supplemental performance measure.

   

  Similarly, the Council recommends that gains or losses generated from debt restructurings be included as an integral part of the REIT industry's supplemental performance measure. However, consistent with GAAP, the Council believes that gains or losses associated with debt extinguishment are extraordinary items and should be excluded from the industry's supplemental performance measure.

   

  The Council notes that some believe this modification to the industry supplemental performance measure is inappropriate because it would:

   
• Create additional volatility
• Provide components in the measure which could be used to "manage" earnings
• Potentially reduce the comparability between companies with different business strategies

   

  In conjunction with this recommendation, the Council notes that when there is a gain or loss from a property sale, a part of the proceeds generally recaptures some or all of the accumulated depreciation charged previously to net income. Because GAAP net income recognizes the gain or loss, as well as the depreciation charged previously, it is consistent. Likewise, the REIT industry's supplemental performance benchmark, which currently excludes real estate-related depreciation from its calculation, must be internally consistent when computing gain or loss on sale. Therefore, the question arises as to how accumulated, added-back depreciation charges on property sold should be treated to ensure that there is consistent treatment of depreciation under the REIT industry's supplemental performance benchmark. Otherwise, the measure could overstate gains and understate losses due to the potential asymmetrical treatment of depreciation and amortization never charged to the REIT industry's supplemental performance benchmark. The Council notes that the simplest approach appears to be the use of total cumulative cost, less depreciation and amortization chargeable to the industry's supplemental performance measurement, and not net book value in computing gain or loss on sale for purposes of the REIT industry's performance benchmark. Comment on how this adjustment may be accomplished is sought and will be considered by the Council in refining its views for future presentation to NAREIT's leadership. (The Council notes that this approach will be affected in part by the final recommendation with respect to Modification No. 3 below).

   

  Potential Modification No. 3
  Depreciation- and Amortization-related Adjustments Made to GAAP Net Income
  in Computing the REIT Industry's Supplemental Performance Benchmark

   

  As stated earlier, the Council believes that REITs and publicly traded real estate companies would rely solely on GAAP net income if not for historical cost depreciation accounting standards currently in use that result in what it and most informed observers consider excessive earnings charges each period. The Council further believes that the current historical cost depreciation model fails to recognize adequately the complex interplay among shifting market values of buildings, appreciation of underlying land and the real, economic depreciation of real property. In particular, GAAP historical cost depreciation of real estate assets generally does not reflect a realistic residual value (or salvage value) at the end of a property's depreciable life. In addition, some observers believe that current GAAP depreciation methods do not produce a pattern of charges over time that matches the long-term revenue potential of income-producing real estate.

   

  Largely for the above-stated reasons, GAAP net income has been repeatedly disputed and criticized with respect to the performance of companies whose assets are predominately income-producing, depreciable real estate. In the past, NAREIT has presented proposals to the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) to remedy what it and many others believe to be this significant accounting deficiency under GAAP. Although the FASB and the SEC recognize the deficiency, they have yet to change established practice under GAAP. Consequently, the Council believes that adjusting GAAP net income, by adding back certain or all depreciation and amortization taken under GAAP, provides the basis for a useful supplemental performance measure for the REIT and publicly traded real estate industry. A supplemental performance measure along these lines should provide the broadest spectrum of investors and other stakeholders an appropriate earnings measure and a more complete understanding of the performance of publicly traded real estate companies.

   

  The 1991 definition of FFO specified that depreciation and amortization were to be added back to GAAP net income, without specifying what items were to be included. The 1995 FFO White Paper clarified the definition of FFO to ensure that companies did not add back to GAAP net income "depreciation or amortization of assets other than those uniquely significant to the real estate industry." Examples of items permitted to be added back included "real property depreciation," "amortization of capitalized leasing expenses," and "tenant allowances and improvements." Specifically excluded were items such as the "amortization of deferred financing costs, depreciation of computer software, company office improvements, and other items commonly found in other industries and required to be recognized as expenses in the calculation of net income." Since 1995, industry practice has varied, contributing to the criticism of FFO.

   

  Under the approach being considered by the Council, the REIT industry's supplemental performance benchmark would adjust GAAP net income only to reflect the add-back of certain or all depreciation and amortization. Thus, the main issue on which the Council seeks comment is which, and to what extent, depreciation and amortization should be added back to GAAP net income to compute the REIT industry's supplemental performance benchmark.

   

  There are a wide range of alternatives with respect to the treatment of depreciation and amortization in the REIT industry's supplemental performance benchmark. The alternatives identified thus far include:

   
• Add back all GAAP depreciation and amortization to GAAP net income.
• Maintain the current NAREIT policy - add back to GAAP net income depreciation and amortization of assets "uniquely significant to the real estate industry."
• Same as alternative B except that depreciation and amortization of all assets which clearly wear out over an identifiable, short period of time, or that clearly relate to identifiable, short-term revenue streams, would not be added back to GAAP net income.
• Same as alternative B except that depreciation and amortization of all assets with depreciable lives of less than "X" years would not be added back.
• Add back to GAAP net income the difference between: GAAP depreciation and amortization, and the amount of depreciation and amortization calculated using a method which results in what NAREIT and others believe is an appropriate depreciation and amortization charge to the earnings of income producing real estate (e.g., sinking fund depreciation or salvage value depreciation).

   

  The following is a brief discussion of each of these alternatives:

   

  Alternative A:

  Add back all GAAP depreciation and amortization to GAAP net income.   Some believe that adding back all depreciation and amortization shown on the GAAP income statement provides the clearest, most transparent and credible earnings measurement. Their reasoning is that both the starting point, GAAP net income, and the add-back, GAAP depreciation and amortization, are GAAP numbers that come directly from the GAAP income statement. Therefore, each of these numbers and their combination (as the industry's potential supplemental performance benchmark) are auditable based on GAAP. This alternative produces a uniform, transparent and highly credible benchmark. At the same time, a significant shortcoming of this alternative is that the industry benchmark would include no capital maintenance charges - not even costs that are not "uniquely significant" to real estate operations or costs that relate directly to current and short-term revenue streams.   Alternative B: Maintain the current NAREIT policy - add back to GAAP net income depreciation and amortization of assets "uniquely significant to the real estate industry."   Some believe that the industry's depreciation and amortization add-back should remain unchanged from the policy set forth in the 1995 "White Paper." They believe that tweaking this calculation before solving the GAAP depreciation problem would provide only nominal improvement in the industry's performance benchmark and is not worth the potential confusion of the change. The most significant criticism of this alternative is that it does not result in depreciation and amortization of expenditures that are incurred to maintain the current revenue stream (e.g., normal, on-going capital maintenance and leasing related costs).   Alternative C: Same as Alternative B except that depreciation and amortization of all assets which clearly wear out over an identifiable, short period of time, or that clearly relate to identifiable, short-term revenue streams, would not be added back to GAAP net income.   Using this method to arrive at the industry's depreciation and amortization add-back would result in a charge to the supplemental benchmark for depreciation and amortization of expenditures required to maintain and possibly enhance the current- and near-term revenue stream. This would reduce the benchmark for the depreciation and amortization of expenditures, which most analysts deduct from current FFO in calculating Adjusted Funds From Operations (AFFO), Funds Available for Distribution (FAD) or Cash Available for Distribution (CAD). Some believe that this adjustment yields a more appropriate measurement of the economic profitability of operating real estate. Others would prefer to not exclude these depreciation and amortization charges from the benchmark and rely on disclosures about on-going capital maintenance expenditures to provide investors and analysts with information to make appropriate adjustments.   Alternative D: Same as Alternative B except that depreciation and amortization of all assets with depreciable lives of less than "X" years would not be added back.   This alternative is similar to Alternative C, but rather than charging the industry benchmark with depreciation and amortization of certain types of assets, the charges are based on the depreciable lives of assets. The depreciation and amortization of assets with lives less than a specific number of years (e.g., 5, 10, or 20 years), would not be added back to GAAP net income. While an initial reaction to this method is that a "bright line" would result in uniformity, many believe that in practice depreciable lives would be arbitrarily biased toward lives exceeding the "bright line." Others believe that this method would yield inappropriately high depreciation charges for properties and/or operations with significant amounts of short-lived assets.   Alternative E: Add back to GAAP net income the difference between: GAAP depreciation and amortization, and the amount of depreciation and amortization calculated using a method which results in what NAREIT and others believe is an appropriate depreciation and amortization charge to earnings (e.g., sinking fund depreciation or salvage value depreciation).   This alternative results in a depreciation charge to the industry supplemental benchmark that the industry agrees should be appropriate under GAAP. It produces a benchmark that the industry would hold out and promote as an appropriate GAAP net income number. Although neither of the two methods discussed below are GAAP today, the inclusion of one of these or another method in the industry supplemental performance measure may set the stage for its acceptance as GAAP in the future. The industry would work with the appropriate accounting standard setters toward having the depreciation and amortization method selected under this alternative accepted as GAAP. The two such methods which have been promoted by the industry at various times and which have official acceptance outside the United States are:   sinking fund depreciation salvage value depreciation   Sinking fund depreciation is accepted under Canadian GAAP and is used by virtually all members of the Canadian Institute of Public Real Estate Companies to depreciate operating real estate. Under this method, the cost of a property is depreciated in a manner similar to a principal amortization schedule on a long-term, fixed-rate mortgage. This, of course, results in increasing periodic depreciation charges over the life of the property - a pattern compatible with a property's increasing revenue stream. There has been much written about the sinking fund depreciation method. In 1982, it was approved by the American Institute of Certified Public Accountants (AICPA). However, the FASB rejected the AICPA's position. The advantage of this method is that it is relatively simple and has been used for over 20 years by some NAREIT-member companies. The experience of these members would make implementation easier.   Salvage Value Depreciation is a method which NAREIT and the National Association of Real Estate Companies (NAREC) developed in 1996-1997. Generally, this method results in a charge to earnings for the cost of a property in excess of its current fair value. Properties are not written-up above cost under this method, but are not depreciated below fair value. Applying this method would require periodic valuations of property. These could be simple valuations of net operating income, without third party appraisers involved. Many believe that this method of depreciation most faithfully represents the economic reality of operating real estate depreciation. It is also a method which is generally supported by the most recent position of the International Accounting Standards Committee (IASC), a group that establishes accounting standards on an international basis. The IASC represents more than 100 member-countries and sets standards that influence U.S. accounting standards. The IASC is currently considering the issuance of an exposure draft that will require "investment real estate" to be carried on the balance sheet at fair value, not depreciated, and that changes in value be reported in the income statement. A final vote on the proposed standard is expected this fall. The U.S. will not be subject to this standard, but will certainly be influenced by it over time. In addition to this global support, some believe that using fair value in the determination of depreciation for income producing properties is supported by current thinking with respect to fair value accounting for financial instruments. Those that take this position rely on the similarities of certain economic characteristics between long-term bonds and income-producing real estate.   Regardless of which of the Alternatives A through E is selected, the Council believes that the industry supplemental performance measure should be defined in a manner that supports and encourages attestation by independent auditors.   Note on Presentation and Disclosure of Depreciation - Many analysts require a clear understanding of capital expenditures, tenant improvements, and leasing costs in order to calculate cash-based measurements of profitability. Regardless of the outcome of the Council's proposals with respect to the add back of depreciation and amortization, it will continue to be important for companies to provide information with respect to these types of on-going expenditures. In addition, the amounts of depreciation and amortization that would be eligible and ineligible to be added back to GAAP net income to calculate the industry supplemental performance measure should be presented separately either on the face of the GAAP income statement or disclosed in the notes to the financial statements. The Council believes that these disclosures are vitally important and would encourage disclosure of these expenditures regardless of the alternative implemented.   Accompanying Disclosure   The Council believes that sufficient disclosure accompanying the REIT industry's supplemental performance benchmark is critically important. As a result, the Council is considering what supplemental disclosures should be appropriate to accompany the REIT industry's supplemental performance benchmark.   Consistent with current practice and the existing definition of FFO, the Council believes that any adjustments to net income for unconsolidated partnerships and joint ventures should be disclosed on the same basis and calculated consistently with any final modifications.   The Council also believes necessary, accompanying disclosures should include the other disclosures recommended in the existing definition and clarification of FFO. Specifically, companies should reconcile the REIT industry's supplemental performance benchmark to GAAP net income and include a line item breakdown of each of the adjustments used in the calculation. The reconciliation should be sufficiently detailed to provide investors with a material understanding of the differences between GAAP net income and the REIT industry's supplemental performance measure. Additional disclosures also should include material capital expenditures, including tenant allowances, tenant improvements, capitalized leasing costs, expansions and major renovations, floor coverings, appliances, and exterior preparation and painting. Depending on the circumstances surrounding an individual property, a disclosure should also be provided showing the non-cash effect of straight-line rents that affect periodic results. Further, as with the reporting of GAAP net income, companies should report the REIT industry's supplemental performance measure both before and after GAAP extraordinary items.   The Council also believes that computation and publication of an individual company's industry supplemental performance measure should always be consistent with NAREIT's stated definition and that deviations should not be reported. The industry's supplemental performance measure should never be "as adjusted" to accommodate adjustments, such as those that some companies now make to FFO with respect to straight-line rents. Although the adjustment usually has been disclosed, the practice substantially undermines uniform reporting and the fundamental shift to an industry measure that more closely tracks GAAP net income.   The Council also is mindful of the disclosures and practices that the SEC requires with respect to all non-GAAP financial measures (e.g., FFO, EBITDA, EBDT, etc.). These practices are described in SEC Accounting Series Release No. 142. They include: 1) that the measure not be given greater authority or prominence as GAAP net income in financial reports; 2) that a clear description or tabular presentation of the calculation be provided; 3) that an indication is provided that the measure is not a GAAP indicator of performance or of cash flows; 4) the reason why the measure is presented and how management uses the information; 5) that prior periods presented must be calculated consistently with the current period; and 6) that the measure not be reported on a per share basis in SEC filings.   Most real estate companies currently report FFO per share in earnings releases and disclosures that typically accompany the releases. The Council believes that the industry's supplemental performance measure on a per share basis should be calculated and disclosed consistent with FASB Statement No. 128 with the substitution of the industry's supplemental performance measure for net income.   Comments on these and other potential disclosures are encouraged.   Effective Date   In the event NAREIT leadership, after considering comments from industry participants, determines in the future that there should be changes made along the lines discussed in this paper, the Council is evaluating whether the industry's supplemental performance measure should be changed at one time or in a two-step approach providing for more extensive review of depreciation-related issues. The two approaches currently being considered are:   One-time - Adopt all Potential Modifications effective January 1, 2000 or some other date. Two-step - First adopt Potential Modification No. 1, later adopt Potential Modifications No. 2 and 3 after further consultation with FASB, industry standard-setters, etc.   In either case, the Council also requests comment on the proposed effective date of any change, the timing of a name change, as well as whether companies should be encouraged or required to restate all years presented to reflect the new benchmark. The Council also seeks comment on alternative approaches to implementing any modification.   Definitions   The definition of FFO is as follows:   FUNDS FROM OPERATIONS means net income (computed in accordance with generally accepted accounting principles), excluding gains (or losses) from debt restructuring and sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect funds from operations on the same basis.   The 1995 NAREIT White Paper on Funds From Operations clarified the definition of FFO by specifying that the add back of depreciation or amortization to GAAP net income be related to those assets "uniquely significant to the real estate industry."   The potential redefinition of FFO, the REIT industry's supplemental performance measure, is as follows:   "FUNDS FROM OPERATIONS [OR THE CHANGED NAME OF THE REIT INDUSTRY'S SUPPLEMENTAL PERFORMANCE BENCHMARK] means net income (computed in accordance with generally accepted accounting principles) plus qualifying depreciation and amortization."   In keeping with the existing definition of FFO and the recommendations contained in "Accompanying Disclosures" above, any new definition would also be "after adjustments for unconsolidated partnerships and joint ventures" and "adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect" the REIT industry's supplemental performance benchmark on the same basis.   Comments   A roster of the Best Financial Practices Council is attached. The Council looks forward to serious and thoughtful input from all REIT and publicly traded real estate company stakeholders. Your comments are strongly encouraged and your views will be considered fully before recommendations to the NAREIT Board of Governors are completed. Please send your comments to NAREIT c/o George Yungmann, Senior Advisor, Financial Standards, 1875 Eye Street, NW, Suite 600, Washington, DC, 20006-5413. George may be reached at (202) 739-9432 and via email at gyungmann@nareit.com. Additionally, you may contact David Taube, NAREIT's Financial Standards Analyst, at (202) 739-9442 and dtaube@nareit.com. You may also want to contact all or any of the co-chairs of the NAREIT Accounting Committee: Steve Richter, Weingarten Realty Investors, srichter@weingarten.com; Tim Peterson, American Real Estate Investment Corporation, tpeterson@areic.com; and Barry Lefkowitz, Mack-Cali Realty Corporation, blefkowitz@mack-cali.com. Please forward your comments no later than August 20, 1999.   June 22, 1999