Real Estate Investment Trusts (REITs): These firms are sort of like private equity
firms, but for properties rather than companies. They buy and sell properties, operate
and improve them, and sometimes even develop new properties.
REITs might be diversified, or they might focus on a specific sector like commercial,
residential, retail, industrial (ex: warehouses), healthcare, and so on; some firms might
have a geographic concentration as well.
REITs are required to issue 90% of their taxable income as dividends to avoid
corporate-level income tax and that requirement combined with their constant
acquisition and development of new properties results in minimal cash on-hand most
of the time.
So they have huge financing needs and need to issue debt and equity constantly just to
continue operating.
Sure. For individual properties, Net Operating Income (NOI) is one of the key metrics
and is similar to EBITDA for normal companies. NOI is equal to Revenue Minus
Operating Expenses Minus Property Taxes, and excludes Depreciation, Amortization,
and Corporate-Level Income Taxes.
The NOI divided by the Property Value equals the propertys Cap Rate (also called
the Yield in the UK and other regions), which is typically anywhere from 5-10%.
Its the inverse of valuation multiples: a 20x multiple corresponds to a 5% Cap Rate, and
a 10x multiple corresponds to a 10% Cap Rate.
Then on the REIT side, you can sum up all the REITs individual properties to get a
picture of what the entire firm looks like.
Technically, you can calculate NOI and Cap Rates for REITs, but the most important
metric by far is Funds from Operations (FFO), which is defined as Net Income +
Depreciation & Amortization Gain / (Loss) on Sale of Real Estate.
The idea is to say, On a normalized, recurring basis, how much in earnings are we
generating?
Gains and losses are non-recurring, so theyre subtracted; and D&A is extremely large
but its non-cash and deceptive for real estate because most properties increase in
value over time.
That is just the basic idea you see all sorts of variations, such as Adjusted Funds from
Operations (AFFO), where you subtract Maintenance CapEx to more closely
approximate cash flow, and then metrics like AFFRO that make other adjustments
depending on the industry (e.g. straight-lining of rent).
All REITs break out FFO in their filings, so thats your best source for the actual
numbers.
Dividend yields and dividend payout ratios are also important to analyze for REITs
because of the requirement to issue 90% of taxable income as dividends to avoid
corporate-level income taxes.
Sure Ill start with the intrinsic side:
Dividend Analysis (AKA Dividend Discount Model): This approach considers a 5year projection with discount rates as well as a terminal value calculated either by a
multiple or a perpetuity growth approach.
Discounted Cash Flow: Stream of Funds Available for Distribution = FFO normalized
recurring capital expenditures. As you know, this requires determining cost of capital,
and discounting streams into present value.
With REITs, DCFs and Dividend Discount Models can often give you similar values
because FFO Recurring CapEx tends to be close to the actual dividends issued.
Net Asset Value: This one is specific to real estate, and its different from what you see
for oil & gas companies and other types of NAV models.
The idea is that you take the REITs projected NOI and divide it by the appropriate Cap
Rate (you can go granular and divide this into different regions or property types) to
figure out the value of their gross real estate assets.
Then you add in other assets, exclude Accumulated Depreciation, and subtract
Liabilities to determine the NAV. You can also calculate NAV Per Share and look at the
premium or discount to the companys current stock price.
Capital raisings are far more common, at least for REITs as mentioned above, they
constantly need to raise debt and equity to continue acquiring, developing, and
renovating properties. Financings are more common in the other sectors as well.
M&A is not quite as common because there arent too many REITs to begin with its
not like other industries where there were hundreds or thousands of potential targets, so
most acquisitions are of assets (individual properties) instead.
Firms also tend to lack cash and the ability to raise debt (since theyre already heavily
leveraged), so 100% stock deals are the most viable option, but those present risk to
both parties.
When M&A does happen, geographic presence tends to be a key driver: one firm is
strong in the Northeastern US but wants to expand to the Midwest or Southwest, for
example.
Deal flow also runs in patterns: if one real estate firm raises capital, a competitive firm
will likely do the same. In fact, I had one week where all the biggest REITs raised equity
right after one another.
This is not to say that youll never get exposed to M&A, but financings are definitely
more common here.
