Welcome to REIT investing 101! Andrew Carnegie is quoted as having said that “90% of Millionaires got their Wealth in Real Estate”. Funny thing though, he made his fortune as an industrialist, not in real estate. So, perhaps not the savviest man in real estate, but brilliant in business nonetheless. If one of history’s biggest industrialists had such high regard for real estate, maybe you and I should also.
But what if you don’t have enough money to invest in real estate? Or maybe you have enough, but all your money would be tied up in a single property, not diversified investments? That’s when Real Estate Investment Trusts (REITs) come in handy!
REITs are investment vehicles that were created for anyone to invest in Real Estate without the hassle of managing properties. 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). We’d like to share with you a REIT 101 intro, the main metrics you want to look at, and then introduce some REITs we like and explain why we like them.
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REITs are companies that own and manage real estate and receive rental income from those properties. While most REITs are equity REITs, meaning that they own and operate real estate properties, some REITs specialize in investing in mortgages and mortgage-backed securities. The latter are called mortgage REITs, or mREITs for short. Hybrid REITs invest in both equity and debt. In this post, we focus solely on equity REITs.
To qualify as REITs for tax purposes, the company must 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 are categorized by the industry in which they are specialized:
REIT Financial Metrics
While REITs can add a lot of value to an income-seeking investor portfolio, it’s important to understand the main metrics. Real estate has its own lingo and financial metrics, and so do REITs. Below, we explain basic metrics that relate to REITs.
Funds From Operations (FFO)
FFO is probably one of the most useful metrics to use to analyze a REIT’s performance. FFO replaces what earnings is for a regular company. Because REITs can take a big accounting depreciation (real estate can depreciate heavily), FFO was created as 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 Per Share as the equivalent of Earnings Per Share (EPS) for other stocks.
Net Operating Income (NOI)
Another important metric for REITs is NOI. This metric takes into account the Operating Expenses (OPEX) and measures how efficiently a REIT manages its properties. A REIT with a growing NOI is probably efficient at using its properties.
NOI = Real Estate Revenue – OPEX
Net Asset Value (NAV)
NAV is another metric that is analogous to familiar metrics in other companies, specifically the Book Value; when expressed per unit, it’s equivalent to the 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 REIT’s ability to raise capital in the future. As its name implies:
LTV = Mortgage Amount / FMV (Fair market value of properties)
When searching for a good REIT in which to invest, your due diligence does not end with the review of these four metrics. Use the metrics to screen REITs and narrow down your list of candidates to those that meet your minimum criteria. Then, you must go deeper in your due diligence before pulling the trigger.
It’s time to share with you three REITs we like, and show their basics.
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Essex Property Trust (ESS)
- Industry: Residential
- Market Cap: $15B
- Dividend Yield: 4.03%
- 5-year dividend growth: 4.43%
ESS is primarily engaged in the ownership, operation, management, acquisition, and development of predominantly apartment communities, located along the West Coast of the U.S. The company owns about 252 apartment communities.
ESS is everything a REIT should be: dominant in a thriving market, a decent yield, and stellar dividend growth history. Most income-seeking investors look for high-yield REITs, but those often come with marginal growth opportunities. If you’re willing to invest in a REIT with a yield of about 4%, consider ESS; your income will be safe, protected against inflation, plus you’ll likely enjoy some value appreciation over the long haul.
During the recession of 2008, ESS sustained its dividend growth while maintaining a strong FFO/share; it positioned itself to thrive once the economy was on a roll again. ESS regularly acquires apartment REITs and integrates them successfully. The forecasted decline in apartment supply in California combined with growing population point to a high demand for ESS properties. Finally, the stock price is appealing after its 2022 decline, as ESS continued to report modest growth throughout 2023, a great sign of stability.
- Industry: Specialty
- Market Cap: $80B
- Dividend Yield: 1.99%
- 5-year dividend growth: 9.16%
Equinix is a digital infrastructure company that owns and operates data centers. Its interconnected data centers around the world allow its customers, organizations in finance, manufacturing, retail, transportation, government, healthcare, and education, to bring together and interconnect the infrastructure they need to track their digital advantage.
The beauty behind the EQIX business model is that it is both poised for strong growth and hard to replicate. EQIX excels in matching customers in the data and cloud service arenas with each other. Its cloud-based global platform, through a distributed infrastructure, is a critical source of differentiation, making EQIX the partner of choice for some of the largest technology companies. With over 10,000 customers, including 1,800 networks, EQIX is a well-diversified cash cow. The EQIX yield is low and won’t pay an investor’s bills, but its capital appreciation potential could boost a portfolio over the long haul.
VICI Properties (VICI)
- Industry: Diversified
- Market Cap: $31B
- Dividend Yield: 5.59%
- 5-year dividend growth: 0%
VICI owns portfolios of gaming, hospitality, and entertainment destinations, including Caesars Palace Las Vegas, MGM Grand and the Venetian Resort Las Vegas. Its destinations are subject to long-term triple net leases, where tenants pay for for property taxes, insurance, and maintenance costs. VICI’s geographically diverse portfolio consists of 54 gaming facilities across the United States and Canada comprising approximately 124 million square feet and features approximately 60,300 hotel rooms and more than 450 restaurants, bars, nightclubs, and sportsbooks.
This REIT offers great protection against inflation as its contracts include an escalator clause where rents increase by 1.8% annually. VICI also minimizes its risk by leaving most of the expenses to its tenants. It has a unique business model among REITs since its tenants (mostly casinos) sign incredibly long contracts as they are highly dependent on their location and the size of the property to operate their business. In other words, VICI has a sticky business model.
What should I do with REITs?
REITs are a great addition to any portfolio and a great way to get exposure to real estate. This doesn’t mean they are risk free. Even though their value is tied to real property, a bad move can damage them just as companies in other sectors. Finally, it’s tempting to focus on high yield REITs, but some of those could be traps. You want to make sure your future dividend payments are safe and at least beat inflation.
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