Real Estate Investment Trusts (REITs) and Real Estate Operating Companies (REOCs) are increasingly becoming a larger part of the Toronto Stock Exchange (TSX) index. This is occurring for several reasons, but includes an aging demographic looking for income from a relatively stable source such as real estate. In addition, the decline in interest rates and bond yields globally has increased the value of real estate over the past several years, something which has caught the attention of investors.
Investing in publicly listed real estate stocks also has several advantages compared to purchasing direct real estate. Firstly, real estate stocks offer better liquidity than direct real estate as they can be bought and sold more quickly in the stock market. Second, the capital requirements are lower as investors can purchase a single stock as compared to an entire property. Lastly, investors are able to gain exposure to real estate without the expertise or time requirements of being a landlord.
The TSX is now comprised of over 50 REITs/REOCS in various sectors such as office, retail, industrial, multi-family, and hotels. As well, the REITs/REOCs have begun investing beyond Canadian borders and into foreign countries such as the United States, Germany, France, Netherlands, Brazil, and even Mongolia! The wide range of sectors and geographies provides investors with multiple options and ways to diversify their real estate holdings.
In terms of valuing REITs/REOCs as an investment, there are two primary methods. The first if by determining Net Asset Value (NAV). NAV is the intrinsic value of the REIT/REOC and is generally calculated by taking the value of the properties less total debt. Generally, REITs/REOCs will trade within a narrow premium or discount of the stocks’ NAV. Investors should look to acquire REITs/REOCs trading at a deep discount to its NAV and subsequently, look to dispose of REITs/REOCs trading at a steep premium to NAV. It is important to note the NAV can be heavily influenced by the estimated net operating income and the capitalization rate applied to the properties.
The other primary method to value REITs/REOCs is by Adjusted Funds From Operations (AFFO). AFFO is the net cash flow generated by the REIT/REOC. AFFO various from NAV, as it goes below the property operating income level and accounts for G&A expense, interest expense and maintenance capex (capex required to sustain the income generated). As such, it is generally used as a measure of the available cash available to distribute to investors in the form of distributions or dividends. Analysts and investors will typically apply a multiple to AFFO to determine the value of the REIT/REOC.
Overall, there are many factors to analyze when considering an investment in a publicly listed real estate stock. Investors must go beyond the headline “yield” being offered by the REIT/REOC as too high a yield is often a sign of troubled times ahead. Investors should look at all factors which include the REITs/REOCs valuation, leverage, payout ratio, quality of assets, and track record of management. By assessing all these factors, investors will have made a more informed decision with a better chance of success.
Mainstreet Equity Corp. is a publicly traded (TSX: MEQ) residential real estate company in Canada. Mainstreet currently owns and operates properties in Surrey, BC; New Westminster, BC; Abbotsford, BC; Calgary, AB; Cochrane, AB; Edmonton, AB; Fort Saskatchewan, AB; and Saskatoon, SK.
Mainstreet provides affordable, renovated apartment suites to Canadians, and is committed to creating real value without diluting shareholder interests.