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Know your REIT Terminology - 18 Jun 2017 12:17

Tags: reit

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If you are investing for dividend income Real Estate Investment Trusts (REITs) will be a major investment in your portfolio and is a subject I do not touch on often enough on this blog but I should being as REITs make up 15% of my personal portfolio. That said, I am sharing a post of a recent Motley Fool Article written by Matthew Frankel that I thought was worth sharing that defines common REIT terminology.

(here is a link to the full article)

1. Funds from operations (FFO)
This is perhaps the most important term you need to know to be able to properly evaluate REITs. Most other stocks are judged based on "earnings" or net income, and ratios based on earnings, such as the price-to-earnings multiple. However, net income doesn't accurately reflect a REIT's profits because of a real estate-specific accounting metric known as depreciation. In a nutshell, the REIT version of earnings is "funds from operations" (FFO), so you should consider it as such when reading a REIT's financial results.

2. Adjusted funds from operations (AFFO)
Going a step further, most REITs emphasize adjusted or normalized FFO figures in their reporting. Simply put, this is a company-specific way of expressing FFO in a way that's most relevant to shareholders and analysts. Keep in mind, however, that this is not a standardized accounting metric, and its calculation can be slightly different between companies.

3. Capitalization rate (cap rate)
This is the net operating income generated by a property, relative to its purchase price. A property that costs $1 million and generates $60,000 in net operating income would have a cap rate of 6%. When evaluating properties to buy, an REIT looks for the highest cap rates available for the desired level of risk the REIT's management is comfortable taking on.

4. Funds available for distribution (FAD)
This is similar to FFO or AFFO, but subtracts recurring real estate expenditures and some other items to express how much money is available to pay out as dividends.

5. Cost of capital
REITs have two basic ways to finance the acquisition of new properties — issuing equity, or taking on debt. The cost of capital refers to the dividend rate and expected growth of issued stock, or to the interest expense incurred on debt. Lower costs of capital generally translate to more favorable environments for acquisitions. As an example, a low cost of capital allowed retail REIT Realty Income Corp. to roughly double its initial acquisition goal for 2016.

6. EBITDA or NOI
Also known as net operating income (NOI), EBITDA is a common financial metric, and stands for "earnings before interest, taxes, depreciation, and amortization." In evaluating REITs, the debt-to-EBITDA ratio is often used for assessing a company's debt level.

7. Equity REIT
This refers to a real estate investment trust whose primary business is owning and renting properties. This is as opposed to a mortgage REIT, which is a company that invests in mortgages and/or mortgage-backed securities. A hybrid REIT invests in a combination of properties and mortgages.

8. Leverage
Simply put, leverage refers to debt. Specifically, REIT leverage is often expressed as either a percentage of total capitalization or a percentage of equity capitalization. For example, if a REIT reports leverage of 30% of total capitalization, this means that 30% of the REIT's total capitalization is made up of debt, with the other 70% made up of the market value of its equity capital.

9. Net asset value (NAV)
This refers to the total market value of all of a company's assets. For a REIT, this means the market value of its properties, plus the value of any other assets it owns. Admittedly, this is a somewhat subjective metric, because there are several ways to assess the value of the same property.

10. Total return
REITs are "total return" investments, which means that their goal is to produce a combination of income and share-price growth. Total return refers to the combination of the two, and is generally expressed on an annualized basis. For example, a stock that pays a 4% dividend yield and rises in price by 6% in a year would have generated a total return of 10% for that year. - Comments: 0

Is DGI the Perfect Answer to Inflation? - 24 Jan 2015 14:48

Tags: i-bonds inflation planning reit

Finding an investment product that can provide an income and at the same time continually rise to exceed the inflation rate is a primary goal for many retirees or soon to be retirees.

Finding such a vehicle is a daunting task. Fixed Income (bonds, preferred stock & fixed annuities) while low risk, operates just as it names describes. They provide a fixed income over time with no increases. It is predictable but cannot combat inflation.

Investing in stocks on the other hand does have the potential to grow and beat inflation. In the world of stocks, the dividend growth investing (DGI) strategy claims that a stock that continually grows their dividend is a sound hedge against inflation. But is this really the case? To prove this theory I analyzed a small basket of DG stocks that have been paying dividends for 25 or more years:

  • Aflac (AFL)
  • AT&T (T)
  • Coca-Cola (KO)
  • Emerson Electric (EMR)
  • ExxonMobil (XOM)
  • Johnson & Johnson (JNJ)
  • Leggett & Platt (LEG)
  • McDonalds (MCD)
  • Procter & Gamble (PG)
  • Wal-Mart (WMT)

Note: Considered posting graphs for all stocks but that would have made this post pretty busy so instead contrasting graphs of PG & WMT will be used. If anyone would like the data for the other stocks leave a post and it will be provided.

Of all the stocks, only WMT has consistently increased annual dividends at a rate that beat inflation. This is rather surprising as they are so closely tied to the economy. Other than WMT, each position failed to increase their dividend that exceeded the inflation for at least one year. The primary data points discovered were:

Average Inflation non-beat; once every 8 years (7.88 yrs to be exact)
Average dividend growth to inflation rate growth during the non-beat; -5%

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WMTinflat.png

While not perfect, DGI is pretty darn effective! Though one could argue that the years that they did beat inflation, the dividend growth exceeded the inflation rate by such a large amount that it compensates for any one-time loses giving your long term growth rate a positive factor and this is a sound statement.

But, what if your income did not meet or was just meeting your expenses at the start of retirement? You may have been planning on that growth from the start and the years you do not beat inflation could hurt. With people living longer it is not unreasonable to assume a 30 year retirement of which there will be 3 times during that period where income growth will fail to beat the inflation rate.

While DGI is extremely effective it is not a 100% solution. Question now is; are their alternatives that can reduce the risk?

Diversify with Real Estate Investment Trusts

REITS tend to be influenced by different factors than the overall market and has growth at different cycles. In theory this should also apply to their dividend growth. To confirm this I analyzed:

  • Realty Income Corp (O)
  • HCP Inc (HCP)

The two REITs dividend growth also failed beat inflation once every 8 years but that 8 year cycle was completely different. When our basket of stocks failed to match the inflation rate REITs beat it and vice-versa.

Another factor discovered is the amount they failed to beat the inflation rate was much lower on average; -1.3% versus -5% for our basket of stocks.

By diversifying with REITs we reduce risk and spread losses out over different years leading to the conclusion that some REIT positions are necessary components for DGI.

Are there other alternatives? Most likely…wish to share? I'm willing to listen & learn. - Comments: 0

Defensive Addition to My Portfolio - 22 Feb 2014 21:33

Tags: hcp reit

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Over the last 9 months REITs (Real Estate Investment Trusts) have been in a sell-off. This sell-off has finally motivated me to buy my first REIT in an effort to diversify my portfolio. In addition to increasing my portfolio diversity I also have the goal of picking a defensive stock in the case of a significant market drop by owning an alternative investment in the form of property. A REIT is easier than actually buying property and the headaches that come with it as well as also being more liquid.

I settled with a purchase of 54 shares in HCP at a price of $37 per share and a dividend yield of 5.8%. HCP’s health care property investments are the most diverse in their industry and tenant income source is just as diverse as it is spread (almost evenly) between Private investment, Medicare, & Medicaid.

Additionally HCP has increased its dividend for 29 straight years, has a 10 year dividend growth average of 2.4%, and is the only REIT currently a member of the S&P 500 Dividend Aristocrats Index. HCP is quite proud of its inclusion in the index and heavily advertises as such, of which helps attract new investment when HCP requires capital for property growth. - Comments: 0


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