How To Value REITs In 2024 | Real World Examples

Up to date on November twenty second, 2024 by Bob Ciura

Actual property funding trusts – or REITs, for brief – give traders the chance to expertise the financial advantages of proudly owning actual property with none of the day-to-day hassles related to being a standard landlord.

For these causes, REITs could make interesting investments for long-term traders seeking to profit from the earnings and appreciation of actual property.

The sheer variety of REITs implies that traders may profit from the implementation of a basic, bottom-up safety evaluation course of.

With this in thoughts, we created a full listing of over 200 REITs.

You possibly can obtain your free 200+ REIT listing (together with necessary monetary metrics like dividend yields and payout ratios) by clicking on the hyperlink under:

As a result of there are such a lot of REITs that at the moment commerce on the general public markets, traders have the chance to scan the trade and spend money on solely the best-of-the-best.

To do that, an investor should perceive methods to analyze REITs.

This isn’t as simple because it sounds; REITs have some completely different accounting nuances that make them distinctly completely different from frequent shares relating to assessing their funding prospects (notably as regards to valuation).

With that in thoughts, this text will talk about methods to assess the valuation of actual property funding trusts, together with two step-by-step examples utilizing an actual, publicly-traded REIT.

What’s a REIT?

Earlier than explaining methods to analyze an actual property funding belief, it’s helpful to know what these funding autos actually are.

A REIT is not an organization that’s centered on the possession of actual property. Whereas actual property firms definitely exist (Howard Hughes Holdings (HHH) involves thoughts), they don’t seem to be the identical as an actual property funding belief.

The distinction lies in the way in which that these authorized entities are created. REITs are trusts, not firms. Accordingly, they’re taxed in another way – in a means that’s extra tax environment friendly for the REIT’s traders.

How is that this so?

In change for assembly sure necessities which might be essential to proceed doing enterprise as a ‘REIT’, actual property funding trusts pay no tax on the organizational stage.

Probably the most necessary necessities to take care of REIT standing is the fee of 90%+ of its web earnings as distributions to its house owners.

There are additionally different vital variations between frequent shares and REITs. REITs are organized as trusts.

Consequently, the fractional possession of REITs that commerce on the inventory change should not ‘shares’ – they’re ‘items’ as an alternative. Accordingly, ‘shareholders’ are literally unit holders.

Unit holders obtain distributions, not dividends. The explanation why REIT distributions should not known as dividends is that their tax therapies are completely different.

REIT distributions fall into 3 classes:

Bizarre earnings
Return of capital
Capital positive factors

The ‘abnormal earnings’ portion of a REIT distribution is essentially the most simple relating to taxation. Bizarre earnings is taxed at your abnormal earnings tax fee; as much as 37%.

The ‘return of capital’ portion of a REIT distribution will be regarded as a ‘deferred tax’. It’s because a return of capital reduces your value foundation.

Which means you solely pay tax on the ‘return of capital’ portion of a REIT distribution while you promote the safety.

The final element – capital positive factors – is simply because it sounds. Capital positive factors are taxed at both short-term or long-term capital positive factors fee.

The proportion of distributions from these 3 sources varies by REIT. Basically, abnormal earnings tends to be the vast majority of the distribution.

Count on round 70% of distributions as abnormal earnings, 15% as a return of capital, and 15% as capital positive factors (though, once more, this may differ relying on the REIT).

REITs are greatest suited to retirement accounts as a result of the vast majority of their funds are taxed as abnormal earnings.  Retirement accounts take away this damaging and make REITs very tax advantageous.

This doesn’t imply you need to by no means personal a REIT in a taxable account. funding is an efficient funding, no matter tax points. However when you’ve got the selection, REITs ought to undoubtedly be positioned in a retirement account.

So what are the impacts of the tax therapies of a REIT in comparison with different forms of funding autos? In different phrases, how a lot does a REIT’s tax effectivity increase its traders’ after-tax earnings?

Think about an organization makes $10, pre-tax, and distributes 100% to traders. The picture under exhibits how a lot of the $10 would go to traders if the corporate was arrange in every of the three main company entity varieties (firms, actual property funding trusts, and grasp restricted partnerships):

REITs are considerably extra tax-efficient than firms, primarily as a result of they forestall double-taxation by avoiding tax on the organizational stage.

With that stated, REITs should not fairly as tax-efficient as Grasp Restricted Partnerships.

Associated: The Full MLP Record: Excessive-Yield, Tax-Advantaged Securities

The tax-efficiency of REITs makes them interesting in comparison with firms. The rest of this text will talk about methods to discover the most tasty REITs based mostly on valuation.

Non-GAAP Monetary Metrics and the Two REIT Valuation Methods

The final part of this text described what a REIT is, and why the tax effectivity of this funding automobile make them interesting for traders.

This part will describe why REITs can’t be analyzed utilizing conventional valuation metrics, and the choice strategies that traders can use to evaluate their pricing.

REITs are house owners and operators of long-lived property: funding properties.

Accordingly, depreciation is a big expense on the earnings statements of those funding autos. Whereas depreciation is a actual expense, it isn’t a money expense.

Depreciation is necessary as a result of, over time, it accounts for the up-front capital expenditures wanted to create worth in an actual asset.

Nevertheless, it isn’t an expense that ought to be thought-about for the aim of calculating dividend security or the chance {that a} REIT defaults on its debt.

Additionally, depreciation can differ over time. In a standard straight-line depreciation scheme, extra depreciation is recorded (on an absolute greenback foundation) at first of an asset’s helpful life.

The fluctuations in depreciation expense over time implies that assessing the valuation of a REIT utilizing web earnings (as the normal price-to-earnings ratio does) is just not a significant technique.

So how ought to an clever safety analyst account for the actual financial earnings of a REIT?

There are two major alternate options to conventional valuation strategies. One assesses REIT valuation based mostly on financial earnings energy, and the opposite assesses REIT valuation based mostly on earnings era capabilities. Every might be mentioned intimately under.

As a substitute of utilizing the normal ratio of worth and worth (the price-to-earnings ratio), REIT analysts usually use a barely completely different variation: the price-to-FFO ratio (or P/FFO ratio).

The ‘FFO’ within the price-to-FFO ratios stands for funds from operations, which is a non-GAAP monetary metric that backs out the REIT’s non-cash depreciation and amortization expenses to provide a greater sense of the REIT’s money earnings.

FFO has a widely-accepted definition that’s set by the Nationwide Affiliation of Actual Property Funding Trusts (NAREIT), which is listed under:

“Funds From Operations: Web earnings earlier than positive factors or losses from the sale or disposal of actual property, actual property associated impairment expenses, actual property associated depreciation, amortization and accretion and dividends on most well-liked inventory, and together with changes for (i) unconsolidated associates and (ii) noncontrolling pursuits.”

The calculation for the price-to-FFO ratio is similar to the calculation of the price-to-earnings ratio. As a substitute of dividing inventory worth by earnings-per-share, we dividend REIT unit worth by FFO-per-share. For extra particulars, see the instance within the subsequent part.

The opposite technique for assessing the valuation of a REIT doesn’t use a Non-GAAP monetary metric. As a substitute, this second technique compares a REIT’s present dividend yield to its long-term common dividend yield.

If a REIT’s dividend yield is above its long-term common, then the belief could possibly be considered as undervalued; conversely, if a REIT’s dividend yield is under its long-term common, the belief could also be overvalued.

For extra particulars on this second valuation approach, see the second instance later on this article.

Now that we’ve got a high-level rationalization of the 2 valuation strategies out there to REIT traders, the following two sections will present detailed examples on methods to calculate valuation metrics relative to those distinctive authorized entities.

Instance #1: Realty Revenue P/FFO Valuation Evaluation

This part will function a step-by-step information for assessing the valuation of REITs utilizing the price-to-FFO ratio. For the aim of this instance, we’ll use real-world publicly-traded REIT to make the instance as helpful as potential.

Extra particularly, Realty Revenue (O) is the safety that might be used on this instance. It is likely one of the largest and most well-known REITs among the many dividend development investor neighborhood, which is due partially to its fee of month-to-month dividends.

Supply: Investor Presentation 

Month-to-month dividends are superior to quarterly dividends for traders that depend on their dividend earnings to pay for all times’s bills. Nevertheless, month-to-month dividends are fairly uncommon.

For that reason, we created an inventory of practically 80 month-to-month dividend shares.

Simply as with shares, REIT traders have to decide on whether or not they’d like to make use of ahead (forecasted) funds from operations or historic (final fiscal 12 months’s) funds from operations when calculating the P/FFO ratio.

To seek out the funds from operations reported within the final fiscal 12 months, traders must determine the corporate’s press launch saying the publication of this monetary information.

Notice: Adjusted FFO is superior to ‘common’ FFO as a result of it ignores one-time accounting expenses (normally from acquisitions, asset gross sales, or different non-repeated actions) that can artificially inflate or cut back an organization’s noticed monetary efficiency.

Alternatively, an investor may additionally use forward-looking anticipated adjusted funds from operations for the upcoming 12 months.

For instance, we anticipate Realty Revenue to generate adjusted FFO-per-share of $4.17 in 2024. The inventory at the moment trades for a share worth of $58, which equals a P/FFO ratio of 13.9.

So how do traders decide whether or not Realty Revenue is a lovely purchase in the present day after calculating its price-to-FFO ratio?

There are two comparisons that traders ought to make.

First, traders ought to evaluate Realty Revenue’s present P/FFO ratio to its long-term historic common. If the present P/FFO ratio is elevated, the belief is probably going overvalued; conversely, if the present P/FFO ratio is decrease than regular, the belief is a lovely purchase.

Prior to now 10 years, Realty Revenue inventory traded for a mean P/FFO ratio of roughly 18.6, indicating that shares seem undervalued in the present day.

The second comparability that traders ought to make is relative to Realty Revenue’s peer group. That is necessary: if Realty Revenue’s valuation is enticing relative to its long-term historic common, however the inventory remains to be buying and selling at a big premium to different, related REITs, then the safety might be not a well timed funding.

One of many troublesome elements of a peer-to-peer valuation comparability is figuring out an affordable peer group.

Happily, giant publicly-traded corporations should self-identify a peer group of their annual proxy submitting with the U.S. Securities & Trade Fee.

This submitting, which exhibits as a DEF 14A on the SEC’s EDGAR search database, accommodates a desk much like the one under:

Supply: Realty Revenue 2024 Definitive Proxy Assertion

Each publicly-traded firm should disclose an analogous peer group on this proxy submitting, which is tremendously useful when an investor needs to match a enterprise’ valuation to that of its friends.

Instance #2: Realty Revenue Dividend Yield Valuation Evaluation

As mentioned beforehand, the opposite technique for figuring out whether or not a REIT is buying and selling at a lovely valuation is utilizing its dividend yield.

This part will present a step-by-step information for utilizing this method to evaluate the valuation of REITs.

On the time of this writing, Realty Revenue pays an annual dividend earnings of $3.16 per unit. The corporate’s present unit worth of $58 means the inventory has a dividend yield of 5.5%.

Realty Revenue’s 10-year common dividend yield is 4.5%. Once more, Realty Revenue’s higher-than-average dividend yield signifies shares are undervalued proper now.

For the reason that belief’s dividend yield is larger than its long-term common, it seems that in the present day’s worth is a lovely alternative so as to add to or provoke a stake on this REIT.

A peer group evaluation would seemingly yield an analogous outcome, as most REITs in its peer group have yields exceeding 4%. Directions for figuring out an affordable peer group for any public firm will be discovered within the earlier part of this text.

The dividend yield valuation approach for actual property funding trusts will not be as strong as a bottom-up evaluation utilizing funds from operations.

Nevertheless, this method has two major benefits:

It’s faster. Dividend yields can be found on most Web inventory screeners, whereas some lack the aptitude to filter for shares buying and selling at low multiples of funds from operations.
It may be generalized to different asset courses. Whereas REITs (and a few MLPs) are the one safety varieties that report FFO, it’s clear that each dividend-paying funding has a dividend yield. This makes the dividend yield valuation approach an acceptable technique for valuing REITs, MLPs, BDCs, and even firms (though the P/E ratio remains to be the perfect technique for firms).

Closing Ideas

Indisputably, there are definitely benefits to investing in actual property funding trusts.

These securities enable traders to profit from the financial upside of proudly owning actual property whereas additionally having fun with a very passive funding alternative.

Furthermore, REITs are very tax-advantageous and normally provide larger dividend yields than the typical dividend yield of S&P 500 securities.

REITs even have analytical nuances that make them harder to research than firms. That is notably true relating to assessing their valuations.

This text supplied two analytical strategies that may be utilized to REIT valuation:

The P/FFO ratio
The dividend yield valuation approach

Every has its advantages and ought to be included within the toolkit of any dividend development investor whose funding universe consists of actual property trusts.

You possibly can see extra high-quality dividend shares within the following Positive Dividend databases, every based mostly on lengthy streaks of steadily rising dividend funds:

The most important home inventory market indices are one other stable useful resource for locating funding concepts. Positive Dividend compiles the next inventory market databases and updates them month-to-month: