“90% of Millionaires got their Wealth in Real Estate” … Are you investing in Real Estate?
“90% of Millionaires got their Wealth in Real Estate” is one of those quotes that has always been stuck in my mind when I think about deploying capital. Funny story, that is a quote from Andrew Carnegie, who made a fortune as an industrialist. He might have not been the wisest person in Real Estate, but we know he was brilliant in business. If one of the biggest industrialists in history gives Real Estate that much respect, I believe I should too. But what if you do not have enough money to invest in Real Estate? Or maybe you have accumulated enough but all your net worth would be tied to one property and not diversified? That is when Real Estate Investment Trusts (REITs) come in handy!
REITs are investment vehicles that were created for anyone to invest in Real Estate without all the hassle that managing real property brings. REITs are accessible to the average investor regardless of the amount of money they can invest. Just as any other publicly traded company, you can start investing as long as you can afford one share (usually not more than $500). In this edition of Dividend Monk, we would like to share with you a quick intro to REITs (REITs 101), the main metrics you want to look at, and finally, a few examples of REITs we like.
REITs are companies that own and manage Real Estate and receive rental income from those properties. Even though most REITs are equity REITs, there are REITs that specialize in investing in mortgages (mortgage REITs) and some that invest in both equity and debt (hybrid REITs). In this section we will focus solely on equity REITs.
To qualify as REITs for tax purposes, the company most receive at least 75% of its income through rent or sales of properties. REITs must also pay a minimum of 90% of their taxable income in dividend each year, something that makes them very attractive to dividend investors. REITs can be identified by the industry in which they are specialized:
While REITs can add a lot of value to an income-seeking investor portfolio, it is important to understand the main metrics. Real Estate is known for its specific lingo and financial metrics, and REITs are no exception. Because this is not a purely technical article, we would like to cover the following basic metrics:
Funds From Operations (FFO)
FFO is probably one of the most useful metrics that an investor can use to analyze a REITs performance. FFO replaces what earnings is for a regular company. Because REITs can take a big accounting depreciation (Real Estate can be heavily depreciated), FFO was created to have a more objective measure of performance for a REIT. The FFO formula is:
FFO = Earnings + Depreciation (Amortization) – Proceeds from Property Sales
There is a small variation of FFO called AFFO or Adjusted FFO. AFFO simply adds back capital expenditures (CAPEX) which gives a different picture of financial performance:
AFFO = Earnings + Depreciation (Amortization) – Proceeds from Property Sales – CAPEX
You can think of FFO as the equivalent of Earnings Per Share (EPS) for other stocks.
Net Operating Income (NOI)
NOI is another important metric for REITs. This metric takes into account Operating Expenses (OPEX) and is a measure of how efficient a REIT is at managing its properties. A REIT with a growing NOI is probably signaling an efficient use of its properties.
NOI = Real Estate Revenue – OPEX
Net Asset Value (NAV)
NAV is another metric that is analogous to familiar metrics in other companies. NAV can be thought as Book Value, and when expressed in a per unit manner it is the equivalent to a Price-to-Book ratio.
NAV = Total Property Fair Market Value – Liabilities
Loan to Value (LTV)
The LTV ratio is a good metric to analyze the REITs ability to raise capital in the future efficiently. As its name implies:
LTV = Mortgage Amount / FMV (Fair market value of properties)
This is not a comprehensive list of things you should do in your due diligence. These metrics should be used as screeners for companies where if they fit your criteria, then you do deeper due diligence before pulling the trigger. Next, we would like to share three REITs that we like and their basics.
Essex Property Trust (ESS)
- Market Cap: $17B
- Dividend Yield: 3.35%
- 5-year dividend growth: 5.5%
ESS is a REIT that is primarily engaged in the ownership, operation, management, acquisition, and development of multifamily. The company specializes in apartment complexes located predominantly along the West Coast. The company owns approximately 246 apartment communities.
This is a REIT that is sometimes overlooked by income-seeking investors due to its relatively low yield. What these investors are missing, is the fact that with ESS your income will be safe and protected from inflation with very strong growth. With such an amazing management team and expertise, you might even experience some value appreciation in the long haul! We firmly believe that ESS will be one of the few safe bets as we face an imminent recession.
Digital Realty (DLR)
- Market Cap: $34B
- Dividend Yield: 4.05%
- 5-year dividend growth: 5.7%
DLR is a company that has been becoming more popular in recent times. The company has a very strong track record of increasing dividends since 2005. DLR is in the Data Center business, one of the “new” sectors for REITs that requires a certain level of expertise.
One of the things we like about DLR the most is its clients. DLR client list includes IBM, Meta, Oracle, and Verizon. These companies heavily rely on DLR’s data centers for growth and performance. DLR has a strong portfolio of properties across a number of high-demand areas, high occupancy, and robust customer retention. Finally, DLR has a very impressive healthy balance sheet, which will allow it to take advantage of acquisition opportunities.
Innovative Industrial Partners (IIPR)
Market Cap: $3B
- Dividend Yield: 7.3%
- 3-year dividend growth: 102%
IIPR is unique company in the REIT space. IIPR specializes in the acquisition, ownership, and management of industrial properties leased to state-licensed operators for their regulated cannabis facilities. It is a relatively small player compared to the more “seasoned” REITs, but it shows a promising future.
We would like you to consider IIPR as more of a speculative play. The cannabis industry is growing rapidly, and we are not sure what it will look like in a few years. This will be a very volatile investment, but with a lot of growth potential. This is a great way to get exposure to the growing cannabis business without being 100% exposed to the growers. This is one of those investments where you want to be attentive to the news in terms of regulations. Finally, with the economic slowdown, there is news that one of the REITs main tenants might be defaulting in July 2022, which could be bad news if this trend expanded to other tenants.
What should I do with REITs?
To wrap up this section we would like to mention something about REITs. REITs are a great addition to any portfolio and a great way to get exposure to Real Estate. This does not mean they are risk free vehicles. Even though their value is tied to real property, a bad move could certainly damage the company just as with any other sector. Finally, it can be attractive to focus on yield with REITs, but some of those could be traps. You want to make sure your future dividend payments are safe and at least beat inflation.
If you want to learn more about the strategies we use, we invite you to download our free recession-proof portfolio workbook. It will give you peace of mind and guidance while building your dream portfolio!