Investing in REITs
REITs (Real Estate Investment Trusts) are listed companies or investment vehicles in the real estate sector that trade on the stock market. They allow small investors to access large-scale real estate assets.
- In Spain they are known as SOCIMIs and in Mexico as FIBRAs.
- They are usually exempt from corporate tax if they distribute more than 90% of pre-tax profit to shareholders via dividends.
- They are an option to consider in inflationary environments.
Characteristics
- Cyclicality depends on the type of assets: a data centre REIT is usually less cyclical than a shopping centre REIT.
- Net profit is of limited use because it includes accounting depreciation (D&A), which is not a real cash outflow; properties often appreciate over the medium term. It is better to rely on FFO and AFFO, which are closer to real cash flow (see table below).
Key metrics and definitions
| Concept | Definition |
|---|---|
| NOI (Net Operating Income) | Income from real estate assets minus operating costs of those assets |
| CAP RATE / YIELD % | NOI / Asset value |
| LTV (Loan-To-Value) | Percentage of the asset financed with debt |
| FFO (Funds From Operations) | Net profit + D&A − Gains on asset sales. Multiple: P/FFO. |
| AFFO (Adjusted FFO) | FFO − CAPEX (equivalent to FCF). Multiple: P/AFFO. |
| NAV (Net Asset Value) | Market value of assets − Debt (do not confuse with Book Value). It is very subjective and few companies report the true value of their assets. |
| Triple Net Leases (NNN) | The tenant bears all costs; usually implies lower rents |
What to analyse in a REIT
Assets
- Type of REIT and the assets it comprises.
- Rent per m², occupancy rate, quality of tenants and assets.
- Geography and cyclicality of the asset type.
- Depreciation and trend of the assets.
Compare these figures with direct competitors.
Management
- If management is external: review the team’s track record, incentives, alignment of interests and Related-party Transactions.
Leverage and debt
- The sector commonly uses debt; excess debt reduces flexibility in recessions.
- Useful ratios: Debt/FFO, Debt/Equity.
- Review interest rate type (fixed or variable), maturities and cost of funding.
Historical behaviour
- REITs have traded close to their NAV; large discounts have typically occurred in crises (2008, 2020).
- Around ~16.5x P/FFO on average; much lower multiples have also tended to appear in crises.
- The more cyclical the income, the lower the multiple (e.g. hotels).
Resources
- Data and reports on US real estate: Cushman & Wakefield – United States Insights.
TOP company example
- American Tower Corporation.