By Tom Kirtland

REIT managers are frustrated that the financial markets continue to undervalue their companies.

If REIT shares are undervalued, it is partly because the information investors receive through corporate reports has become less relevant in terms of what is needed to make a proper assessment. Forward-looking REIT managers recognize the widening gap between information provided by the traditional reporting model and information desired by investors, and have begun to take the first steps toward transforming corporate reporting into a broader context. But ultimately, such steps must lead to the integration of past results with the strategies, tactics and investments that underscore a company's ability to deliver future value.

It's Not that the Current Reporting Model is Imprecise

Today, all companies are under intense pressure to create and preserve shareholder value. They cannot fully realize this value, however, unless they have an effective reporting program in place to ensure that investors understand their strategies for creating value and are confident in management's ability to deliver on them. The traditional reporting model fails to provide the information needed to analyze companies using the shareholder value metric and its focus on future cash flows.

It's not that the current reporting model, with its painstaking disclosure requirements, is imprecise. Nor is it that REIT accounting practices are abusive or aggressive. Rather, the issue is that the current reporting model measures past results to the exclusion of a host of measures which provide a better indication of future value. The time has come to update the content of the current reporting model to reflect not only what companies did during the last period, but also what they are doing to deliver value in future periods.

Our recent research conclusively demonstrates that despite the investment community's widespread use of corporate reports, less than 20 percent of both investors and analysts regard them as very useful. What's missing is more complete and integrated information about competitors, economic conditions and industry growth, views on the regulatory environment and perceptions about technologies that give important clues about a company's potential. In addition, meaningful information about critical business drivers such as innovation, brands, market share, customers and intellectual capital are completely outside the realm of current reports. The result is an "information gap" between the data provided through the current reporting model and the information the market actually uses to value stocks.

What Companies Stand to Gain

According to surveys that we have conducted, the benefits of providing a broader range of information (closing the information gap) are substantial.

Higher management credibility. Although an intangible benefit, it can be important when management is considering a significant investment that will hurt short-term earnings but deliver meaningful future results. The market will be much more likely to regard this kind of disclosure in a positive way—a higher stock price—if it believes that management can deliver on its promises. It is not always true that the market will penalize a company for short-term earnings dilution—but, in the absence of credibility, the market is unlikely to give management the benefit of the doubt that a transaction actually makes sense.

More long-term investors. If companies provide a broader range of credible information on performance measures other than traditional earnings data—and especially if they present a convincing relationship between these measures and long-term value creation—the market's emphasis on near-term earnings should decline. This frees management to concentrate on long-term growth instead of on unproductive activities which merely boost short-term earnings.

Higher share price. Going forward, the financial markets will insist upon clear, relevant financial information and capital will flow to where investors can evaluate both risk and reward. While many aspects of the financial markets have changed, more information still means less risk. If investors perceive less risk, they may reduce the rate used to discount a company's future cash flows (the cost of capital), resulting in a higher share price. As it stands, most financial reports provide only limited information about the investments REITs are making to create and sustain value over and above net asset value. And investors cannot value what they do not see.

Closing the Information Gap

Consistent with the Financial Accounting Standards Board's efforts to improve business reporting, savvy REIT managers have been developing ways to close the information gap through voluntary disclosure.

PricewaterhouseCoopers' ValueReporting™ format, for example, builds on the recognition that the methods investors use to value stocks and managers use to make strategic and operating decisions are closely related. Any effective reporting format should encompasses four principal elements that provide a methodology for improving the relevance, transparency, and clarity of external communications:

1. Market Overview describes competitors and their competitive positions, assumptions about the macroeconomic environment and industry growth, views on the regulatory environment, and perceptions about current and future technologies.

2. Value Strategy describes the company's overall corporate strategy and its strategies for major business units, as well as how the company intends to implement these strategies in terms of organization and governance structures and processes. In terms of the value strategy, a few REITs now provide, in their annual reports, a diagram of their business model, which clearly and concisely illustrates how their activities are linked to value creation.

3. Managing for Value describes the measures the company believes most closely reflect inputs to and changes in shareholder value, actual income statement and balance sheet results compared to targets and benchmarked against competitors, segment information and information on risk and risk management. In this regard, a number of REITs disclose stabilized yields on their new development projects, and one, in particular, shows a comparison of actual vs. targeted yields for the past five years. Another REIT effectively links the volume of its completed development pipeline to the amount added to shareholder value.

4. Value Platform provides information on the non-financial value drivers, typically the leading indicators of future financial performance, including innovation, intellectual capital, customers, brands, the supply chain, people and reputation. Some REITs have begun to develop and report brand metrics, while others refer to the results of customer satisfaction surveys conducted by independent third parties. Another REIT discloses figures for employee training expenditures and classroom hours. These are just a few examples of non-financial data that might ultimately be linked to financial performance and shareholder value.

In addition, reports to investors should address the cost of capital: how the management defines it, applies it in making decisions, and adjusts it to reflect the different risk profiles of investment opportunities. The analysis should then be linked to historic performance reporting using a shareholder value metric, such as Economic Value Added or Return on Investment. This result, in turn, needs to be contrasted to the markets' assessment of future performance, as measured by near-term Total Shareholder Return.

Market Knowledge vs. Market Guesswork

In the end, a company's stock price depends on its performance. And that is the essence of an effective reporting format—communicating a company's performance as completely and accurately as possible so that investors can properly price its stock. On balance, giving investors the information they need is worthwhile simply because market knowledge is better than market guesswork.