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You can find the other articles in this series below:
Part 1: Understanding the Basics
Part 2: The Seven Types of Equity REITs
Part 4: Building a Diversified REIT Portfolio
Let’s dive in to Part 3: Six Key REIT Metrics to Watch.
Evaluating REIT Performance: Six Key Metrics to Watch
Understanding how to evaluate REITs is crucial for making informed investment decisions. Below is a list of six metrics I’ve learned that are crucial to sizing up a REIT, complete with my commentary on how to apply the metric to your real-life REIT analysis.
Here are the key metrics to consider:
1. Funds from Operations (FFO)
Funds from Operations (FFO) is a measure of a REIT’s cash generated by its operations. It is calculated by adding depreciation and amortization to earnings and subtracting any gains on sales of properties. FFO is a more accurate measure of a REIT’s profitability than net income. When it comes to FFO, the higher the better.
2. Adjusted Funds from Operations (AFFO)
Adjusted Funds from Operations (AFFO) goes a step further by adjusting FFO for recurring capital expenditures required to maintain properties. AFFO provides a clearer picture of the cash available for dividends. When it comes to AFFO, the higher the better. (Check this article out if you are interested in learning how to calculate AFFO).
3. Dividend Yield
The dividend yield is calculated by dividing the annual dividend per share by the current share price. It’s an important metric for income-focused investors. A higher yield might be attractive, but it’s essential to ensure that the dividend is sustainable. I personally look for dividend growers over dividend payers.
4. Debt-to-Equity Ratio
The debt-to-equity ratio measures a REIT’s leverage by comparing its total debt to its shareholders’ equity. A lower ratio indicates less risk, as the REIT relies less on debt financing. However, some debt can be beneficial if used wisely for growth and expansion. While debt is inevitable for most REITs, I strongly prefer lower debt-to-equity ratios when comparing two REITs.
5. Occupancy Rate
The occupancy rate measures the percentage of a REIT’s properties that are leased out. A higher occupancy rate typically indicates strong demand and efficient property management and is crucial for maintaining steady cash flows and profitability. Look for a REIT’s most current occupancy rate in its quarterly earnings release or its website. Obviously, the higher the occupancy rate, the better.
6. Same-Property Net Operating Income (NOI) Growth
This metric measures the income growth from properties that have been owned for a certain period, usually one year. It excludes new acquisitions and sales, providing insight into the organic growth of a REIT’s existing portfolio. This metric is extremely useful in measuring the compentency of the REIT’s management team. If you’re looking for price appreciation from a REIT, it often begins with income growth from existing properties.
Putting It All Together
While there are obviously many other metrics a REIT investor should consider, these six are very important and useful for quickly sizing up a REIT’s financial health and performance potential. Look for REITs with strong (and growing) FFO and AFFO, a reasonable debt-to-equity ratio, high occupancy rates, and consistent NOI growth. REIT investing is challenging but can certainly be rewarding for those with patience, sound research skills and a longer-term investment horizon!
What’s Next?
In our next (and final) article of this series, we’ll discuss strategies for building a diversified REIT portfolio. |
