Buffett's Sale of Stock Puts Focus on REIT
By JONATHAN WEIL
Staff Reporter of THE WALL STREET JOURNAL
Warren Buffett, the billionaire investor who says the best time to sell a stock is never, has sold his stake in First Industrial Realty Trust. So should investors follow him out of the stock his wallet made famous?
For most of the past two years, First Industrial, a Chicago real-estate investment trust, has basked in being the stock recommended by Mr. Buffett as part of a December 1999 charity event. The name of the REIT was tucked inside the 20-year-old wallet auctioned by Mr. Buffett, raising $210,000 for Girls Inc. of Omaha, Neb. But First Industrial's days as a Buffett holding are over. "He owns no shares of the stock," a spokeswoman for Mr. Buffett says.
The spokeswoman declines to say when or why Mr. Buffett sold the stake, which he held personally. But the disclosure comes just as First Industrial is receiving scrutiny over the way it calculates the profit measure most widely followed by Wall Street analysts. Michael Brennan, First Industrial's chief executive, Tuesday declined to comment on Mr. Buffett's departure. "I don't comment on specific activity of specific shareholders," says Mr. Brennan, who also adamantly defends the company's financial-reporting practices.
As reported last year, Mr. Buffett bought 1.8 million shares of First Industrial at about $24 each, a 4% stake, for a total of $43 million. As of 4 p.m. in New York Stock Exchange composite trading Tuesday, First Industrial shares closed at $33.23, up eight cents.
Mr. Buffett recommended First Industrial when the tech-stock rally was near its peak. When share prices dropped, many investors fled the sector's red ink -- and reliance on "pro forma" accounting practices to make their results look better -- by rushing into supposedly safe stocks like REITs, which had real assets, steady dividends and healthy-looking profits. What investors may not have realized, however, is that the REIT industry's widely cited earnings benchmark -- "funds from operations," or FFO -- is just as fuzzy as the dot-coms' pro forma metrics.
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"For investors that have moved into real-estate stocks for safety, it may not be as safe as it seems," says Lee Schalop, a REIT analyst at Banc of America Securities, who rates First Industrial a "market-performer" and says he isn't recommending it. "Of the 32 companies we cover, First Industrial is the most aggressive" in calculating FFO.
The National Association of Real Estate Investment Trusts defines FFO as net income plus depreciation and amortization expenses. The association excludes, among other things, gains or losses on sales of any properties that previously have been depreciated. The reason depreciation is added back is that real estate generally gains value over time. Gains and losses on sales of depreciated properties are excluded because their owners have declared, by depreciating them, that they are holding them for investment purposes rather than as inventory for resale.
Most REITs follow the guidelines set by the association, to which First Industrial belongs. But the guidelines aren't binding, leading to inconsistent pro forma accounting practices throughout the industry.
Unlike the trade group, First Industrial defines FFO to include net gains from sales of previously depreciated properties. The company doesn't disclose that in its quarterly-earnings news releases -- which have given more prominence to FFO than the REIT's lower net income. But the company does reveal how it computes FFO in separate "supplemental information" booklets for investors and analysts. Michael Havala, First Industrial's chief financial officer, says the company's disclosure practices have been evolving and are "as good as, if not the best in, the industry."
First Industrial first reported gains from depreciated-property sales in the first quarter of 2000, and the company began including them in FFO under a line item called "Integrated Industrial Solutions customer sales gain/fees." (First Industrial says gains represent almost the entire line item.) The company recorded $1.2 million in such gains in the first quarter of 2000, or just 3% of its $40.4 million of FFO, according to its supplemental information.
For the six months ended June 30, gains on depreciated-property sales totaled $11.7 million, or 13% of the company's $92.6 million of FFO. Based on the company's guidance, Banc of America's Mr. Schalop notes that analysts project First Industrial will report 2001 FFO of about $190 million, or $4.06 a share. Of that amount, Mr. Schalop estimates 59 cents a share, or nearly 15%, will come from the line item for depreciated-property sales. First Industrial's top executives also benefit from high FFO because FFO is a "primary component" of their bonus and incentive awards, according to the company's proxy.
Messrs. Brennan and Havala say they are aware the company's FFO definition doesn't follow the trade group's guidelines and that gains on sales of investment properties are considered nonoperating items under both generally accepted accounting principles and the association's FFO definition. They say First Industrial includes such gains because it considers them, in effect, recurring inflows of cash. As for the reason the gains on property sales have increased so much this year, they say corporate customers are taking advantage of low interest rates to buy their own buildings rather than lease them.
"Those activities are integral to the company's operations," Mr. Brennan says. For instance, First Industrial frequently contracts to develop custom-built facilities for customers who lease for the first few years and buy later. In those cases, he says, First Industrial is acting more as a developer than a passive investor, even if it is depreciating the property until it is sold.
Another area of investor scrutiny is the way the company has allocated purchase prices within newly acquired real-estate portfolios. For the second quarter of 2000, for instance, its biggest acquisition was a portfolio of 18 properties around Dallas for $44.3 million, or $34 a square foot, which it bought for investment purposes. About nine months later, it sold three of the properties for $12.1 million, or $38.39 a square foot. That produced an unusually large gain. The sale included the two properties in the portfolio with the lowest purchase-price allocations, at $20.17 and $21.55, respectively. That raises questions about whether those outsize FFO gains are sustainable; the average purchase price assigned to the 15 remaining properties is more than $36 a square foot.
The company says they are sustainable. Mr. Havala, the finance chief, says he had hoped to sell the three properties quickly when the company bought them. Mr. Havala says First Industrial didn't have those Dallas-area properties independently appraised, but that the purchase-price allocations were appropriate. He explains that company executives wouldn't intentionally boost FFO at the expense of higher taxes and, thus, reduced cash flow.
Write to Jonathan Weil at jonathan.weil@wsj.com3
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