Alt Investments #40 - Publicly Traded Real Estate Securities Flashcards
List and describe types of publicly traded real estate securities
LOS 40.a
Equity REITs
- mostly exempt from corp income tax
- actively managed
- own income-producing real estate
- seek profits by growing cash flows, improving property values, purchasing additional properties
- often specialize in one particular kind of property
- diversify over geography and other factors
- UPREIT - “umbrella pertnership”; most common in US where REIT is general partner with controlling interest in partnership that owns and operates the properties
- DOWNREIT - REIT has an ownership interest in more than one partnership; can own properties both at partnership and REIT levels
Equity: REOCs (real estate operating companies)
- ordinary companies that own real estate
- not tax-advataged; form REOC if ineligible as REIT, e.g:
- intend to develop/sell RE & not generate cash
- in a country not allowing tax-advataged REITs
Debt: residential/commercial mortgage-backed securities (CMBS/RMBS)
- asset-backed securitized debt obligations
- cash flow from underlying pool of mortgage loans
- Much larger market than publicly traded equity REITs
Debt: mortgage REITs
- invest primarily in mortgages, mortgage securities, loans secured by real estate
Pros/cons of investing in publicly traded real estate securities
LOS 40.b
Advantages
- superior liquidity
- lower minimum investment
- limited liability
- access to premium properties
- active professional management
- protections in accordance to publicly traded securities
- financial reporting, disclosure, governance
- board and public investor oversight
- greater potential for diversification
REIT-specific advantages (not REOCs)
- tax exemption - most of dividends is return of capital
- predictable earnings - rental income fixed by contracts
- high yield - required to pay out most taxable income as dividends
Disadvantages
- taxes - miss out on tax deductions enjoyed through direct ownership: losses and like-kind property replacements
- lack of control
- cost overhead of REIT structure
- market price volatility
- structural conflicts of interest - sell vs. raise capital different taxation for shareholers vs general partners
- limited potential for income growth
- forced equity issuance - if debt too expensive
REIT-specific disadvantages (not REOCs)
- lack of flexibility - due to REIT structure requirements:
- not able to mkae certain kinds of investments
- must distribute most of income
explain economic value determinants of REITs
LOS 40.c
Largest driver of econ. value for all REITs: national GDP growth
Ranking of factors driving econ. value for REIT property types:
REIT population job new space retail sales
type growth creation supply/demand growth
retail 3 2 3 1
office 3 1 2 4
residential 11 3 4
healthcare 1 3 2 4
industrial 2 4 3 1
hotel 3 1 2 4
storage 1 2 3 4
1 = most important; 4= least important
explain investment characteristics of REITs
LOS 40.c
- exempt from corp income taxes
- high yield dividend
- low income volatility
- secondary equity offerings - more common with REITs than with non-real estate companies
explain principal risks of REITs
LOS 40.c
-
significant supply/demand imbalances likely
- healthcare, hotel, office REITs
-
occupancy rates fluctuate over short time periods
- hotels
-
underlying riskiness of:
- property financing
- in-place leases
- location and quality of property
explain due diligence considerations of REITs
LOS 40.c
Analyst should evaluate:
- remaining lease terms wrt state of economy
- short terms in expanding economy = good
- long terms in declining economy = good
- contractual inflation protection/hedging
- scheduled rent increases = good
- indexing rents to rate of inflation = good
- in-place rents vs market rents
- in-place rents > market rents = good
- costs to re-lease space
- e.g. lost rent, new lease incentives, tenant-demanded improvements, broker commissions
- low = good
- tenant concentration in the portfolio
- no/few big tenants wrt total portfolio = good
- financial health of big tenants; examine their financials
- new competition; examine space that is planned and under construction
- balance sheet analysis; focus on leverage, cost of debt, and maturity of debt
- quality of management; examine performance record, qualifications, and tenture
Describe retail/shopping center REITs
LOS 40.d
retail/shopping center REITs
- regional shopping malls - anchor tenants: long fixed-rate leases; smaller tenants have “percentage leases” (fixed min plus percentage sales over certain level)
- community shopping centers - pre-determined rents with increasing schedle
- econonmic value determinants
- retail sales growth
- job creation
- inv characteristics: stable revenue over short term
- risks: depends on consumer spending
- due diligence: per-sqft sales and rental rates
Describe office REITs
LOS 40.d
office REITs
- long leases (5-25yrs) that increase over time
- tenants pay proportional share of prop taxes, opex, etc.
- econonmic value determinants
- job creation
- new space supply/demand
- inv characteristics: stable revenue over long term
- risks: changes in office vancancy and rental rates
- due diligence: new space under construction; quality of space (e.g. location, condition, etc)
Describe residential REITs
LOS 40.d
residential REITs (apartments)
- econonmic value determinants
- population growth
- job creation
- inv characteristics: one-year leases; stable demand
- risks:
- competition
- inducements
- regional economy
- inflation in opex
- due diligence:
- demographics and income trends
- age and competitive appeal
- cost of home ownership
- rent controls
Describe healthcare REITs
LOS 40.d
healthcare REITs
- econonmic value determinants
- population growth
- new space supply/demand
- inv characteristics: net leases; lease to h/c providers
- risks:
- demographics
- government funding
- construction cycles
- financial condition of operators
- tenant litigation
- due diligence:
- operating trends
- government funding trends
- litigation settlements
- competitions’ new facilities and demand
Describe industrial REITs
LOS 40.d
industrial REITs
- econonmic value determinants
- retail sales growth
- population growth
- inv characteristics: less cyclical; 5-25yr leases; changes in value and income are slow
- risks: shifts in composition local and national industrial bases and trade
- due diligence:
- trends in tenants’ requirements
- obsolescence of existing space
- need for new types of space
- proximity to transportation
- trends in local supply and demand
Describe hotel REITs
LOS 40.d
hotel REITs
- econonmic value determinants
- job creation
- new space supply/demand
- inv characteristics: usually lease through management companies; variable passive rental income; cyclical due to lack of long-term leases
- risks:
- exposed to business cycle
- changes in business and leisure travel
- exposure to travel disruptions
- due diligence:
- occupancy, room rates, operating profit margins vs industry averages
- revenue per available room (RevPAR)
- trends in forward bookings
- maintenance expenditures
- new construction in local markets
- financial leverage
Describe storage REITs
LOS 40.d
storage REITs
- econonmic value determinants
- population growth
- job creation
- inv characteristics: gross leases on a monthly basis
- risks:
- ease of entry can lead to overbuilding/oversupply
- due diligence:
- construction of new competitive facilities
- trends in housing sales
- demographic trends
- new business start-up activity
- seasonal trends in storage demand; can vary greatly in some markets
describe net asset value per share (NAVPS) and justify its usage in REIT valuation
LOS 40.e
NAVPS - per share amount by which assets exceed liabilities using market values (not accounting values)
- considered the most appropriate measure of REIT/REOC fundamental value
- if market price of REIT > NAVPS, REIT likely overvalued
estimate NAVPS based on forecasted cash net operating income
LOS 40.e
1. estimate next 12 month’s cash NOI (NOINTM):
NOITTM
- non-cash rent (avg contract rent - cash rent paid)
+ full-yr adj for acq. (reflect full-yr rent for ppty owned < 1 yr)
+ estimated next-year growth in cash NOI
= cash NOINTM
2. capitalize NOINTM using cap rate to estimate value of operating real estate:
Vop_RE = cash NOINTM / cap rate
3. add value of other tangible assets and subtract value of liabilities to derive total net asset value (NAV):
Vop_RE
+ cash & AR
- debt & other liabilities
= NAV
4. divide by outstanding share count to derive net asset value per share (NAVPS):
NAVPS = NAV / #shares
