Download Public/SIC Education Presentations/REITS[1]

Real
Estate
Investment
Trusts
© Northern NV Chapter
1
REITs and this Class
Any stock mentioned is used as
an example and is not intended as a
recommendation to buy or sell.
Further research should precede any
investment decision by you or your
Investment club.
© Northern NV Chapter
2
What are REITs ?
REITs are Real Estate related
investments which share the benefit of
a stocks liquidity.
When you buy a stock you are
buying a business. The same applies
when you buy a REIT.
3
What are REITs ?
They must have 75% of assets
invested in real estate, mortgage
loans, other REITs or Govt. securities.
REITs are not taxed at the corporate level.
To maintain REIT status they must pay
out 90% of net income as dividends to
owners, and derive 75% of their income
from real estate related business.
4
Types of REITs
Mortgage REITs make and hold loans
and other obligations that are secured by
real estate collateral.
Equity REITs are companies that buy, sell,
manage, renovate, develop real estate.
Hybrid REITs own both properties & mortgages
For this class we will deal exclusively with
Equity REITs
5
REITs & the Market
From Oct. 1981 to Oct 2001 REITS
have given owners a 12.6 %
annual total return.
They have a low correlation with the rest
of the Market and will not rise as fast as
the Market when it becomes bullish, nor
fall as much during bearish times.
6
REITs & the Market
REITS are seen as being less risky
because they have hard assets to back
them up. (Real Estate)
Owners are less likely to sell on a rumor
and hold onto their shares during bear
markets because a significant yield will
soften the blow of declining prices.
7
REITs vs. the Markets
8
Dollar Cost Averaging (DCA)
Re-invest all of your earnings!!!
It has been proven when you increase your
position in stocks you own by regularly
reinvesting during up and down markets you will
lower the overall cost of the stock you own.
First buy is 100 shares at 10.00 per share ($1000)
Second buy 125 shares at $8.00 per share ($1000)
Third buy is 200 shares at $5.00 per share ($1000)
Fourth buy is 100 shares at $10.00 per sh ($1000)
525 sh.
$7.62
$4000
9
REITs role in DCA
Of the almost 11% returns by the market
since 1922 approximately 40% has
come from dividends.
This is due to the “Magic of
Compounding”. This is a result of earning
on your earnings, not just the
principal.
10
REITs role in DCA
If your stock dividend from 100 shares was
15.20 and your share price was $7.62 you
would receive two additional shares upon reinvestment. At the next dividend pay date you
would be receiving dividends from 102 shares.
This dividend payment would be $15.50
(102 times dividend per share of .152 =
$15.50)
11
Importance of Dividends
12
REITs role in DCA
REITs can invest for you while you may be
involved with other projects.
Some investors feel less stressed when they see
regular payments (dividends) reinvested
especially when they don’t write a check for
this to be accomplished.
Larger dividend payments allow you to use
new money to further diversify or add to that
investment.
13
REITs & Total Return
REITs retain little capital for growth,
thus lessening the chance of rapid
price appreciation.
Be sure of where REITs fit into
your portfolio and how you want
to weight them.
14
REITs & Total Return
Only REITs that have easy and cheap
access to capital can grow their business
and make an acceptable long term
growth prospect.
Realize that the yield will make up a
substantial portion of the stocks
Total Return.
15
Why REITs vs. other
High Yield Investments?
Utilities are a highly regulated industry and
must answer to Federal, State, and local
governments.
REITs are less affected by weather,
although retail can be an exception.
Corporate Bonds can be competitive.
Make sure you are dealing with a
financially stable business.
16
Why REITs vs. other
High Yield Investments?
High Yield can also be translated to
mean High Risk. The highest yielding
investment doesn’t mean the
best investment.
Remember the Reward/Risk
factor.
17
So why REITs ?
As mentioned earlier, you can divest quickly if a
situation came up where you had to have money.
They provide significant dividend income with
slow to moderate growth.
You own Real Estate businesses without...
then
18
What kind of REIT is right ?
Diversification is a key!
Diversify by:
Sector
Retail
Residential
Industrial
Hospitals
Hotels
Region
North
South
East
West
Size
Small
Medium
Large
19
Real Estate Cycles
The Depression…High vacancies, low rents and real
estate prices are depressed. Foreclosures and repo’s
are on the rise.
Gradual Recovery…Occupancy rises, rents stabilize
gradually increasing. Property prices regain normalcy.
Still no new or very little construction.
The Boom…high occupancy, rising rents equal better
returns. Construction makes sense.
The overbuilding and downturn…Building outpaces
demand eventually and leads back to depressive state.
Here the cycle is complete and starts anew!
20
REIT Cycles
Commercial REITs are tied not only to the
national economy but to the local economies.
Being to heavy in an industrialized area could
have other trickle down effects.
With layoffs, industrial parks may reduce
occupancy, retail stores may close or relocate.
This may have an effect on apartment vacancies
or other areas where people live or spend their
21
money.
But on the other hand...
Relocation can mean there may be a boom
beginning in another region or industry.
This is where the three areas of
diversifying will lessen any difficulties in
your portfolio.
The strongest and most able companies
will weather the downturns and reward
shareowners in the long run.
22
How to spot the right REIT
As with any investment, good
management will be essential to
continuing satisfactory returns.
Many of the same qualities regular
companies management’s have shown is
what you will be looking for in a REIT.
Have they grown the company?
Remained profitable?
What is their stake in the company?
23
Analyzing Management
Like other companies, the ability of mgt. to
grow the business, (sales and earnings), will be
the single most important aspect of analysis.
The earnings per share growth, while
important, will be compared to FFO or
Funds from Operations
The main difference between FFO and EPS is that
the FFO calculation will give net income before the
depreciation and amortization expense is deducted
24
Analyzing Management
w/ Funds from Operations
Two arguments exist for using FFO vs. EPS.
The first is that real property does not usually
depreciate in value, so to include a depreciation
cost on a property that is appreciating doesn’t
give the accurate picture.
The second is that not all properties appreciate.
Owners need to account for costs associated with
structural improvements to maintain the property
value. Adding back depreciation can therefore
provide an overly positive outlook for the property.
25
Analyzing Management
Online Premium Services, OPS, uses EPS for the
calculation while Value Line gives the FFO figures.
You can plot this manually on the SSG Sec. 1 Chart.
26
Analyzing Management
Note that a Pre-Tax Profit number is given. REITs
do pay taxes on non property related earnings.
27
Analyzing Management
Look for managers who are aware of market
conditions and are capable, and willing, to add
properties when the right opportunity exists.
Be wary of managers who look to make deals
regardless of whether the real estate market is
overpriced. Looking to add rents, “income”,
at any cost may hinder future success.
28
Analyzing Management
REIT’s with the best access to capital will
perform the best over the long term as
they will have financing pre-approved at
usually the lowest rates.
Higher interest expense will reduce future EPS.
Check the financial ratings. (S&P and VL).
Lowest rating before Junk status is BBBHave VL Financial Strength at least B
29
Debt Management
A company that maintains a comfortable level of
debt along with a strong balance sheet will be more
favorable for investment opportunity.
With debt there is also two ways to look at
what is considered a “comfortable” level.
Debt/Market Cap Ratio =
Total Debt/ (Common + Preferred Equity + Total Debt
Debt/Asset Value Ratio =
Total Debt/Total Asset Value
The Debt/Assets Value is more conservative and
usually closer to what the company is actually
30
worth.
Debt Management
What determines a strong balance sheet are
modest amounts of debt relative to it’s
market value or asset value.
Strong coverage of interest payments on that
debt. This means they must have sufficient
cash flows.
31
Debt Management
The REIT must have a manageable
debt maturity schedule.
Know the reasons they are taking on debt...
To grow or improve the properties…good
To pay dividends or other obligations…not good.
32
Debt Guidelines
According to NAREIT the average
debt/market ratio was approx. 46%.
(2001)
Anything over 50% debt ratio is worrisome
to many REIT investors. Especially where
a sector might not be cushioned by long
term leases. (Hotels).
33
Debt Guidelines
A ratio under 40% is considered
conservative and would indicate a well
run and capitalized company.
Competition or overbuilding can make
these levels seem riskier.
34
Debt Guidelines
While NAIC recommends investors look for
companies with debt levels below 33-35%,
remember that REIT’s,by law, pay out 90% of
earnings to shareowners.
This is a reason they may take on more debt
than a standard public company, and equally
important, why they must have easy and cheap
access to capital when the need arises.
35
Interest Coverage
Many REIT investors will also look at the Interest
Coverage Ratio. This ratio will tell the investor
how much of the interest from debt is covered by
Net Operating Income, or NOI.
An example would be High Stakes Property REIT
has NOI of $24 million. Their debt is $120 million,
of which the interest expense is $12 million.
The Interest Coverage Ratio would be
NOI  Int. Expense = 2.0
An Interest Coverage Ratio below 2.5 is cautionary.
36
Final word on debt
Look for variable rate debt to be no more than
10-15% of the REIT’s assets. Rising rates
could bring about negative earnings surprises!
Effective management will refinance debt well
before maturity and seek as long maturity as
possible.
According to Green Street Advisors the amount
of short term debt, (less than two years), is
approximately 5.8%.
37
Insider Ownership
Management that own significant pcts. (%) of
the business they run will, in theory, make the
best decisions for the long term success of that
business.
Green Street Advisors “2001 REIT Pricing”
report stated that the average insider ownership
was 13.6%.
Many REIT’s started out as private, this partially
accounts for the higher numbers. Remember, as a
company issues more shares the percent will decrease.38
Payout Ratios
A low payout ratio allows a REIT to retain
more cash for external growth.
To high of a payout ratio could signal a
possible dividend reduction which would
reduce the price and therefore reduce the
possibility of better access to capital.
For income only REIT’s you’ll want the higher
payout ratio, for REIT’s with growth potential
look for lower payout ratios.
39
Payout Ratios
KIMCo Corp.
Note: Col. F
vs.. Col.C
The payout ratio is calculated in the SSG
by dividing the dividend per share by the
earnings per share, (EPS).
Remember dividends are paid from net
income
40
Capitalization Rates
REIT companies will refer to the income that a
property will produce within a certain period
of time as the “Cap Rate”.
Most often applied to cash flow not net income.
An example would be that if a company was
generating $10,000 per year on a property that
cost $100,00 the cap rate would be 10%.
or
Net income divided by the purchase price = Cap Rate
41
Capitalization Rates
If purchasers were basing their willingness to buy
properties on Cap Rates then you would need an
increase in income, (i.e., rents or leases), to
provide an acceptable return on the purchase
price.
For example, if in ten years you had now increased
the income to $20,000 per year and sold it at the
same 10%Cap rate, you would receive $200,000
for the sale, minus selling costs.
REIT analysts use this number to make
judgments on future FFO estimates.
42
Your Portfolio and REIT’s
NAIC recommends to invest in Growth
Companies.
With this in mind, this is where you or the
Club you belong to should decide whether to
diversify into these type of stocks.
Based on the plus and minuses of REIT’s, would
you or your club feel a desire to have these holdings?
What were some of the plusses and minuses discussed?
Any more?
43
Your Portfolio and REIT’s
Remember if you decide to do this,
follow the NAIC Principles!!!
•Reinvest all earnings to take advantage of
compounding!
•Invest for the Long Term!
•Invest in Quality Companies.
( I left out growth on purpose)!!!
•Diversify, Diversify, Diversify!!!
44
Where to look ?
Value Line has a section for REIT’s.
Go to better-investing.org
and type in an author or
a word to search for topics.
If you only know
the name, click here
and type the name.
Enter the Ticker
symbol for OPS, click GO
45
Resources & Acknowledgments
INVESTING IN REITS
By: Ralph L. Block
BETTER INVESTING AUTHORS
Amy Rauch Neilson
Brian Lewis
Herb Barnett
Ray Smith (WSJ)
WWW.NAREIT.COM
www.dividenddiscountmodel.com
www.reitnet.com
46
Final Thoughts
Be sure to check the chapter web page for the most
updated information on Chapter Classes or events
www.better-investing.org/chapter/nnevada
47