Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

Dividends? Geography? Debt? How to Spot a Well-Designed REIT


Like investing in regular stocks, picking a good REIT requires a lot more effort than just perusing a few key metrics and glancing at a chart.


Just because you know what REIT stands for, doesn't mean you can pick a good one.

In Are REITs Right for Your Investment Type, we discussed some of the positive and negative aspects of REIT ownership, along with the specific rules REITs must follow to retain their favorable tax status. We also learned that REITs may own real estate, mortgages, or some combination of the two and carry several tax benefits for investors, along with a few drawbacks.

So now that you've decided REITs are at least intriguing enough to dig into further, let's examine how best to analyze them to find the ones best suited for your investment goals. Like investing in regular stocks, picking a good REIT requires a lot more effort than just perusing a few key metrics and glancing at a chart. Keep in mind there are professional investors who literally spend their entire day combing through REIT financial statements looking for mis-priced assets and good investments.

In other words, don't expect to beat the market. The best you can hope for is that your thesis, whatever that may be, combined with close examination of different REITs will lead you to the best investment decisions possible. In this piece, we will review at a high level some key metrics and other considerations that are essential to evaluating REITs, and in will subsequent pieces dive deeper into the most important and complex concepts.

Dividends and Yield
REIT investors are often attracted by dividends, which when combined with the possibility for equity growth, make REITs an appealing middle-ground between stocks and bonds. Like bonds, REIT share prices move inversely with yields. That is, a REIT with a $10 share price that pays a $1 dividend per year results in a 10% dividend yield for investors. If the REIT's assets perform well and the share price doubles but dividends stay the same, the yield would be 5% ($1 returned for a $20 share price). This is an extreme example of course, since we know that REITs are required to pay out at least 90% of their net income as dividends. As income grows, dividends tend to grow as well, so yields remain relatively steady over time.

That said, if you buy a REIT share for $10 and the market stumbles, expect dividends to fall on a nominal basis, so not only will your shares be worth less, but that smaller dividend looks even worse when compared to the high share price you bought in at.

Dividend yields vary depending on a host of factors. But like all investments, a good rule of thumb is that a higher yield typically carries higher risk. For example, Simon Properties Group (SPG), one of the largest mall owners in the country, currently yields 2.9% ($3.60 dividend on a $124 share price). Meanwhile, National Retail Properties Inc (NNN), which also operates in the retail space, carries a much higher 6.1% yield. Better, right? Perhaps not.

Simon Properties carries an A- rating from Standard and Poor's, whereas National Retail carries a lower, BBB rating. And while the argument over the validity of these ratings should be saved for a separate piece, by looking further into the two firms financial statements it's easy to see why National Retail could be seen as a riskier bet than Simon Properties. For example, over the past three years National Retail has seen asset values contract, while Simon Properties has seen them expand. During that time period National Retail has seen an 80% rise in its stock price, which isn't half bad. But when compared to Simon Properties' 150% gain, it's clear to see that chasing yield doesn't always pay off.

Leverage is an essential aspect of any real estate investment. When employed properly, leverage can be an incredibly powerful tool to enhance returns. It cuts both ways, however, as we found out all to well during the housing meltdown of 2007-2009, as leverage can push equity losses well above 100%.

Three primary aspects of real estate debt for REIT analysis are: overall debt level, cost of debt and maturities.

Overall debt levels, debt to equity ratios and other metrics are readily available for publicly traded REITs. In the example above, a quick glance at Simon Properties and National Retail yields interesting findings when looking exclusively at outstanding debt. Simon Properties, which the market believes is a lower risk investment with better equity returns than National Retail, carries debt on its balance sheet that is more than three times the amount of its equity. National Retail, on the other hand has more equity than debt. The lesson here is that more debt is not always bad.

Equally as important as debt levels is the cost of that leverage. Cheap debt can greatly enhance returns, but that same amount of debt at a higher interest rate can not only cut into returns, but in some situations create a negative cash flow situation. Real estate loans carry terms that range from the simple-to-understand to the insanely complex, so in certain situations even knowing the current interest rate isn't enough to fully know a REIT's debt expenses.

Another term of any loan is the date of maturity. That is, the time at which the REIT must repay the loan, either via a property sale or refinance. Maturities are particularly important during tough times, because weak cash flow and expensive debt can be managed for a time, but when the loan comes due, real estate owners may have few choices to get out from under the loan. If the property's value has fallen below the amount of the loan (as is the case with many commercial real estate loans currently), when the loan matures the owner must choose between ponying up the difference between the loan amount and the property value, or walk away and hand the keys over to the bank.

Debt, as one may expect, as an absolutely critical aspect of REITs to understand, and will be explained in more detail in another piece.

Funds From Operation (FFO)
Funds from Operations, or FFO, is the most widely watched financial metric when evaluating REITs. Whereas most companies are measured on earnings, earnings in the traditionally sense may be misleading when looking at REITs. FFO is of course not without its shortcomings, but as long as you understand what FFO actually measures, it is an essential part of REIT analysis.

NAREIT, a real estate trade group and lobbying organization, defines FFO as "The most commonly accepted and reported measure of REIT operating performance. Equal to a REIT's net income, excluding gains or losses from sales of property, and adding back real estate depreciation." Essentially, FFO tries to boil down how the REIT's regular operations are faring, or as the name would suggest, how much cash the properties (or mortgages) are kicking off.

Importantly, FFO excludes property sales and depreciation. This makes sense, since selling a building at a loss or gain in a given year is more representative of the owner's relative success with that individual investment, rather than how operations are faring at a given moment in time.

< Previous
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opin= =3D =3D3D ion about the performance of securities and financial markets by = the wr=3D iter=3D3D s whose articles appear on the site. The views expresse= d by the wri=3D ters are=3D3D not necessarily the views of Minyanville Medi= a, Inc. or members=3D of its man=3D3D agement. Nothing contained on the web= site is intended to con=3D stitute a recom=3D3D mendation or advice address= ed to an individual investor =3D or category of inve=3D3D stors to purchase= , sell or hold any security, or to =3D take any action with re=3D3D spect t= o the prospective movement of the securit=3D ies markets or to solicit t=3D= 3D he purchase or sale of any security. Any inv=3D estment decisions must b= e made =3D3D by the reader either individually or in =3D consultation with = his or her invest=3D3D ment professional. Minyanville write=3D rs and staff= may trade or hold position=3D3D s in securities that are discuss=3D ed in = articles appearing on the website. Wr=3D3D iters of articles are requir=3D = ed to disclose whether they have a position in =3D3D any stock or fund disc= us=3D sed in an article, but are not permitted to disclos=3D3D e the size o= r direct=3D ion of the position. Nothing on this website is intende=3D3D d = to solicit bus=3D iness of any kind for a writer's business or fund. Mi= ny=3D3D anville mana=3D gement and staff as well as contributing writers wi= ll not respo=3D3D nd to em=3D ails or other communications requesting inves= tment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

Featured Videos