Real estate investment trust (REIT) valuation has been a complex subject for retail investors since it doesn’t follow the usual price/earnings multiple based valuation or the price to book/sales based valuation methods.
Real estate investment trusts are tax-advantaged companies that are (for the most part) exempt from corporate income tax. They are actively managed and own income-producing real estate, and they seek to profit by growing their cash flows. They often specialize in a particular type of property like shopping center REITs, healthcare REITs or industrial REITs, while still diversifying by geography or other factors.
Price/FFO per Share
The most popular REIT valuation method is P/FFO. P/FFO (or Current market Price/Funds From Operations) per share is very common amongst retail and institutional investors alike.
The formula to calculate Funds From Operations is as follows:
NETINCOME + Depreciation and amortization - Gain on sale of assets
Let’s take actual numbers from LTC properties (LTC ), which is a healthcare REIT. Its annual income statement reveals the following numbers:
*All figures are as of 12-31-2014
On 12/31/2014 LTC had a market price of $43.15. This brings us to its P/FFO per share of 16.92.
Breaking Down the Formula
Real estate, by nature, has a property of appreciating in value rather than depreciating, which is the reason why we need to value it differently—since the EPS, which is used in the traditional price/earnings based stock valuation, accounts for the removal of depreciation. Gain on sale of real estate is subtracted because it isn’t income from continuing operations.
Similar to the PE analysis for any stock, this is P/FFO per share for a REIT, which is then applied in the same fashion you would use to value a stock: You compare it to its industry average and its most direct peers. Undervaluation or overvaluation would depend upon market conditions and future growth prospects for the industry and the company.
*P/FFO or P/AFFO are not easily available because they are non-U.S. GAAP measures and if the company hasn’t voluntarily calculated them for you, you would have to calculate it yourself. Hence the focus on calculation.
Other Key Valuation Techniques
Valuing REITs takes into account a few more things that you might not consider for stocks.
Dividends – REITs are required by law to distribute at least 90% of their earnings to unit holders. This may result in a slight premium that would otherwise not be seen for stocks as investors are guaranteed a payout if the REIT is making money.
Low volatility – Defensive REITs may sometimes display very low volatility, which may result in a higher valuation.
Concentration risk – If a REIT has a majority of properties in a particular state or area then it’s referred to as concentration risk.
Tenant concentration – Risk increases with higher concentration. A REIT analyst should pay special attention to a specific tenant that makes up a higher percentage of space rented or paid.
Type of lease – A triple net lease is a lease where the lessee is required to pay maintenance charges, taxes and insurance to the vendor rather than the landlord, which results in premium valuation for the stock.
Lease maturities – Short remaining lease terms provide an opportunity to raise rent in an expansionary economy while long remaining lease terms are good in a declining economy.
Interest rates – High-interest rates generally have a positive effect on REITs. They make housing or office space more expensive to buy due to higher mortgage rates This sends more people renting space. Looking at the last period of rising rates, we can see the outperformance even better. Between June of 2003 and June of 2006, interest rates rose from 1% to 5.25%. During that time, the Dow Jones U.S. Select REIT Index managed to return 27.68% annually and provided a whopping total return of over 108%.
The Bottom Line
REITs due to their structure have high payouts, and high dividend yields are very popular amongst income investors. A good deal of research is required before investing in REITs, as they don’t receive as much coverage as stocks making it hard to find key valuation metrics.
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DARS™ (Dividend Advantage Rating System) rates dividend stocks across five distinct criteria: relative strength, overall yield attractiveness, dividend reliability, dividend uptrend, and earnings growth. Dividend.com offers free content available to the general public as well as premium subscription service.
For the amount of dividends paid, look at the company's dividend announcement or its balance sheet, which shows outstanding shares and retained earnings.
To calculate the dividend payout ratio, the formula divides the dividend amount distributed in the period by the net income in the same period. For example, if a company issued $20 million in dividends in the current period with $100 million in net income, the payout ratio would be 20%.
Warren Buffett's Berkshire Hathaway BRK.A BRK.B doesn't intentionally buy dividend-paying stocks, but the firm favors financially strong companies with significant competitive advantages run by managers who thoughtfully allocate capital.
Some of the best dividend stocks include Johnson & Johnson (NYSE:JNJ), The Procter & Gamble Company (NYSE:PG), and AbbVie Inc (NYSE:ABBV) with impressive track records of dividend growth and strong balance sheets.
Qualified dividends are taxed at 0%, 15% or 20% depending on taxable income and filing status.Nonqualified dividends are taxed as income at rates up to 37%. IRS form 1099-DIV helps taxpayers to accurately report dividend income.
Sites like CNBC, Morningstar, The Wall Street Journal, and Investopedia are all great resources available for researching dividend data. For example, on Investopedia's Markets Today page, you can use the stock search tool to enter the company name or ticker symbol that you're researching.
For example, say I need to earn $50,000 a year to live comfortably and my average dividend yield is 5%. So, I would need to own $50,000 / 0.05 = $1 million worth of shares to meet my income needs.
Stocks in the S&P 500 index currently yield about 1.5% on aggregate. That means, if you have $1 million invested in a mutual fund or exchange-traded fund that tracks the index, you could expect annual dividend income of about $15,000.
What Is a Good Dividend Yield? Yields from 2% to 6% are generally considered to be a good dividend yield, but there are plenty of factors to consider when deciding if a stock's yield makes it a good investment.
If you have verified and updated your bank account details but still haven't received the dividend, consider contacting the registrar and transfer agent of the company. The registrar and transfer agent can provide insights into any potential issues or discrepancies regarding the dividend payment.
Dividing the stock's annual dividend amount by its current share price allows you to calculate a stock's dividend yield. For example, if a stock is trading at $50 per share, and the company pays a quarterly dividend of 20 cents per share. That company's dividend would be 80 cents.
If a dividend is declared, all qualified shareholders of the company are notified via a press release. The information is usually reported through major stock quoting services for easy reference.
Generally speaking, a DCR of 2 is viewed as good, as this indicates that a company has the capacity to pay its dividends twice over. A DCR of below 1.5 is viewed as a possible concern, signalling the use of loans.
Yes, there are a lot of advantages. However, there's also a price to pay for those benefits. The most obvious advantage of dividend investing is that it gives investors extra income to use as they wish. This income can boost returns by being reinvested or withdrawn and used immediately.
A quick refresher on how dividends work: Companies that earn excess profit can choose to return some of that money to their shareholders, as a sort of thank you, in the form of a regular cash payout. Some investors use these dividends as a form of income.
Monthly dividend stocks can provide predictable income and make budgeting easy since they pay dividends every month of the year. While most companies pay dividends quarterly, there are 80 stocks that pay dividends monthly.
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