In the current low interest rate environment, yield-hungry
investors have been particularly attracted to real estate
investment trusts (REITs), which, as tax-efficient, flow-through
investment vehicles, aim to pay regular cash distributions to their
unitholders. The Ontario Securities Commission (OSC) recently
reviewed the disclosure provided by 30 REITs to assess the quality
and sufficiency of disclosure provided concerning the
sustainability of unitholder distributions. In Staff Notice 51-724Report on Staff's Review of REIT Distributions
Disclosure (Notice), the OSC identifies four areas where, in
its view, improvements are required and for these areas the OSC has
provided examples of acceptable disclosure.
CONTENT OF DISCLOSURE WHERE EXCESS DISTRIBUTIONS ARE PAID
When a REIT's distributions exceed its cash flow from
operations, existing guidance in National Policy 41-201Income Trusts and Other Indirect Offerings (NP
41-201) highlights the expectations of the Canadian Securities
Administrators (CSA) concerning the provision of disclosure
sufficient for investors to understand the risks relevant to the
REIT and its distributions. The Notice specifies that such risks
include the unsustainability of financing excess distributions by
increasing levels of debt (as opposed to increases in underlying
The OSC found that 33 per cent of the reviewed REITs paid
distributions which exceeded cash flow from operations, and that
none of these REITs provided adequate disclosure (per the guidance
provided in NP 41-201) in their MD&A or annual information
forms (in the risk factor section) concerning their excess
The Notice also provides that disclosure regarding excess
distributions should be provided by REITs in situations where
distributions would be in excess of cash flow from operations if
non-cash distributions (including distributions paid in connection
with distribution reinvestment plans) were considered in
quantifying the amount distributed, which the OSC found to be the
case in 13 per cent of the REITs reviewed. The OSC is concerned
that the absence of such disclosure may be misleading to investors
in such REITs.
CONSISTENCY OF DISCLOSURE ABOUT EXCESS DISTRIBUTIONS
International Financial Reporting Standards (IFRS) permit REITs
to record borrowing costs within either cash from operating
activities (reducing cash flow from operations) or cash from
financing activities (not reducing cash flow from operations).
The Notice notes that disclosure regarding excess distributions
should also be provided by REITs in situations where distributions
would be in excess of cash flow from operations if interest paid
was classified as an operating activity on the statement of cash
flows rather than as a financing activity, which the OSC found to
be the case in 10 per cent of the REITs reviewed. The OSC is
concerned that the absence of such disclosure may be misleading to
investors in such REITs.
TIMELY DISCLOSURE WHERE A REDUCTION OR TERMINATION OF
In the Notice, the OSC stresses that it is critical for
investors to be provided with information on a timely basis in
order to understand and assess the risks related to the
sustainability of distributions. It is the OSC's expectation
that sufficient advance notice of any prospective distribution
reduction—either to conserve capital for use in future
projects or because current distribution levels have become
unsustainable—be provided to investors as soon as practicable
and that, in the OSC's view, any such reduction or elimination
of distributions may constitute a material change.
PRESENTATION OF COMMON METRICS SUCH AS ADJUSTED FUNDS FROM
Adjusted funds from operations (AFFO) is a non-IFRS metric
commonly used by REITs to represent the resources that have been
generated by a REIT's operations and are available for
distribution to unitholders. When AFFO represents a cash flow
measure because the adjustments used to arrive at AFFO encompass
adjustments for non-cash items, it is the OSC's view that,
consistent with guidance in NP 41-201 and the CSA's Staff Notice 52-306Non-GAAP Financial Measures and Additional GAAP
Measures, the REIT should provide disclosure that:
Reconciles AFFO to cash flow from operations, being the nearest
Presents cash flow from operations with equal or greater
prominence than AFFO
States explicitly that AFFO does not have any standardized
meaning prescribed by IFRS and is therefore unlikely to be
comparable to similar measures presented by other issuers
Explains why AFFO provides useful information to investors and
how the REIT's management uses AFFO as a financial measure
Explains the nature of adjustments included within AFFO and
employs the same adjustments con-sistently from reporting period to
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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