ALPH : Intro16 Mar 2013 16:40
ALPH
Valuation of REITs:
1. What is a REIT?
A real estate investment trust, or REIT, is a company that owns, and in most cases, operates income-producing real estate.
2. How are they different compared to Stocks?
>>>> REIT stocks are traded like any other company shares all the REITs do not pay any income tax
>>>> Where there are legal complications that may not be possible, like in the UK, a way of avoiding the unfavourable tax consequences they domicile themselves offshore (e.g., in Guernsey or Jersey)
>>>> REITs are usually closed-end funds, what sets them apart from unit trusts is their fixed capital, that means the total amount of capital is fixed and they have a fixed amount of shares
>> Unlike other companies they do not issue any more shares
3. How does the investor benefit from REITs
>>>> REITs pay out large regular dividends
>>>> Unlike manufacturing / service companies at least 90% or in most cases all their income is paid out to the share holders as dividend
>>>> Investors are rewarded by both the appreciation of the REIT share price traded and the dividend paid outs
4. How do you Assess an REIT?
>>>> If you try to estimate the value of a real estate investment trust (REIT) traditional metrics like the earnings-per-share (EPS) ratio, growth, and the price-to-earnings (P/E) multiple do not apply
>>>> The guage of performance of most businesses are net income numbers
>>>> However, that includes depreciation expenses, which are significant line items. For most businesses, depreciation is an acceptable non-cash charge that allocates the cost of an investment made in a prior period
>>>> But real estate is different than most fixed-plant or equipment investments, property rarely loses value and often appreciates in value
>>>> Net income, a measure reduced by depreciation, is therefore an inferior gauge of performance of any REIT
>>>> Therefore, REITs are instead judged by funds from operations (FFO), which excludes depreciation.
>>>> FFO has a disadvantage though, it does not deduct for capital expenditures required to maintain the existing portfolio of properties
>>>> In estimating the value of an REIT, professional analysts therefore use a measure called " Adjusted funds from operations" (AFFO)
>>>> AFFO = FFO MINUS the expenditure on maintenance of the properties
>>>> Although FFO is commonly used, professionals tend to focus on AFFO for two reasons
>>>> One, it is a more precise measure of residual cash flow available to shareholders and therefore a better "base number" for estimating value
>>>> Two, because it is true residual cash flow, it is a better predictor of the REIT's future capacity to pay dividends.
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