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Valuation Tech
Monday, 25 July 2011 10:34



Five Things To Look For In A REIT:

1.    Funds from Operations / FFO payout

2.    Occupancy and Tenant Diversification

3.    Plans for growth

4.    Debt, Cost of Capital and Risks

5.    Dividend Growth


It is often assumed that the most important part of REIT investing is the yield, followed by the stock price in relation to the value of its assets - the lower the ratio the more value is on offer. Several important questions to ask yourself: (1) How much can the REIT grow over the next one, three and five years? (2) Can the REIT be as profitable as it used to be, or at least as profitable as the competition? (3) How does the REIT’s balance sheet compare with the peer group? (4) What is the REIT currently buying and selling? (5) What is the management team’s dividend policy? (6) Is management incentives aligned with shareholders? (7) Any insider buying? (8) What is the value of the company (using both P/FFO and NAV estimates)? (9) Is the dividend safe, and (10) Is there a quantified margin of safety today? Source: Brad Thomas - Link.


Valuation of REIT using Net Asset Value Approach


Last 12 months real estate NOI                   XXX

less:non cash rents                                     XX

Add:full year impact of adjustments            XX

PROFORMA cash NOI for last 12 months=    XXX

Add:Net 12 months cash NOI                       XX

Estimated Net 12 months cash NOI               XXX

Assumed cap rate                                        %

Estimated value of operating real estate       XXXXX


A Worked Example

Joseph Ori - Link.


The Basic Assessment of REIT Safety - Investabiltiy Quotient (BARS-IQ) Score : The BARS-IQ Score (1-100 points)


With the ranking weights below, the highest score a company can receive is 100 points. When added together the score is an investability quotient for investors looking for safety in the REIT space. This proprietary score is a complex yet easy-to-comprehend number that in theory allows investors a basic REIT grading system suitable to their needs.


Each REIT is ranked according to different weightings on the following four criteria: P/FFO, TTM FFO stability, FFO growth (if stable, TTM), the payout ratio and the long-term debt to equity ratio. The weightings rely heavily on pricing, recent FFO stability and the LT debt/equity ratio, as these are the generally accepted mandates of REIT safety. Below the BARS-IQ algorithm is explained.


The BARS-IQ Ranking Metrics (100 Points Max)


1. P/FFO (40% weight)

REITs that are priced lower versus their FFO earn a higher score. Using a proprietary formula, a P/FFO of 11 or lower equals 40 points, while anything above 23.5 earns less than 10 points. The formula is (26.667 - P/FFO) x 2.4 = 40 points maximum.


2. FFO Stability and Growth, TTM (30% weight)

Recent FFO stability and growth are key in determining yield safety. While a dividend cut could spook investors and send the share price into a tailspin, a dividend raise will offer marginally higher pricing. 20 points for FFO TTM stability, 10 points for quarter-over-quarter growth (3 1/3 points each per last three quarters).


3. Payout Ratio (10% weight)

REITs with a payout ratio of over 100% are a higher risk to the investor as it is unstable over time. 8 points for a payout ratio under 100%, 10 points under 95%. A company with a negative TTM FFO receives no points.


4. LT Debt/Equity Ratio (20% weight)

REITs that are over-leveraged risk default on debt or bankruptcy in a sharp economic downturn. While such a crisis is often difficult to forecast, REIT safety is measured here using a proprietary formula where a ratio of 42.6% or below equals 20 points and only ratios under 60% earn a positive score. The formula is (60 - LT debt/equity) x 1.15 = 20 points maximum.

Source: Morgan Myrmo - Link.


Graham Number:

When discussing the subject of how undervalued a company may or may not be, I tend to refer back to Benjamin Graham and a mathematical formula better known as Graham's Number.

According to Eben Esterhuizen the Graham Number is: "a figure that measures a stock's fundamental value by taking into account a company's earnings per share and book value per share. The Graham number is the upper bound of the price range that a defensive investor should pay for the stock. According to the theory, any stock price below the Graham number is considered undervalued, and thus worth investing in. It is used as a general test when trying to identify stocks that are currently selling for a good price."

Source: Matt Schilling - Link




So what's the "everlasting" REIT ingredient? That's easy. It's the dividend. Most of the time the past is no prediction of the future. However, when it comes to the top dividend paying stocks, a REIT's dividend history can give investors some hints about the future. Now it's true, dividend repeatability is an important ingredient for "buy and hold" investors; however, an equally important attribute is the dividend growth. Other important elements to consider are dividend payout ratios. We know that dividend history and yield are important measures of REIT stocks; however, dividend investors must also pay attention to the dividend payout ratio of a company as well. A REIT that continually increases its dividend each year could be a great investment opportunity; however, if the dividend increases are coming at the expense of earnings then there could be a problem. The payout ratio will tell investors how much of a company's earnings are being used to pay the dividend to common shareholders.It's important to remember that there are growth stocks and there are blue-chip dividend stocks. Investors should never overpay for a dividend stock. Even the best investments go on clearance every once in a while. Dividend stocks are no different, and investors should never overpay to own them. One of the best ways to determine the value of a REIT is by utilizing the price-to funds-from operations ratio or P/FFO. By utilizing price to FFO valuation, analysts and investors can determine the trading history of each REIT by itself and relative to the entire REIT sector. Accordingly, payout ratios are based on AFFO (adjusted funds from operations) because it more accurately measures cash flow when compared to net income (due to depreciation), and given the contractual nature of lease payments today (Brad Thomas - Link).


GreenStreet methodology & worked valuaiton example - Link.


Great slide-show article from Avalon Bay Communities - Link.



Last Updated on Tuesday, 08 April 2014 05:57