Here’s how to analyse REITs: The 5 most important things investors need to look out for

In this article, we outline how to analyse REITs (Real Estate Investment Trusts). Despite trading no different to other listed entities, REITs are unique assets with their own metrics that investors can use to determine their performance and whether or not they are overvalued and undervalued. We outline the most important of them as well as yardsticks investors can use to ‘sort the good from the bad’.

 

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5 key ways to answer ‘How to analyse REITs?’

 

1. Profit

Yes, this goes without saying. But two things must be borne in mind.

First, this isn’t the only metric to use. And second, it differs somewhat from profits recorded by ordinary companies because it takes account of property valuation fluctuations.

Take BWP Trust’s (ASX:BWP) recent FY23 result. BWP recorded a $487m profit from ordinary activities in FY22, but this dropped to just $36m in FY23. This was mostly because of the fall in the property market – it made a $372m gain in FY22, but a $77m loss in FY23.

Investors should be looking at not just the one-off result, but also at what caused it and how it compares with the previous year.

 

2. Occupancy

A REIT with a high quality portfolio should have a very high-occupancy rate. In our view, nothing under 90% may indicate one of two things (or perhaps both).

First, that the market the REIT is in is a market in bad shape. And second, that the individual portfolio is not up to scratch. If your REIT is in the office space, it is more likely to be the first at the moment. If it is another, you’ll need to do your homework to determine which is the case – or perhaps if both is the case.

 

3. Yield

REITs tend to pay out 90-100% of their FFO to their investors. While investors may be content with the certainty of income, investors should look at the yield (the % of share price the payout is).

In our view, if a REIT’s yield is above inflation, it is a good investment. This is particularly so, in the current high-inflationary environment.

 

4. FFO

For this metric – Funds from Operations or FFO – we will not give a yardstick figure and will just say you should treat it similarly to profit. You should look at how the figure compares to the previous year as well as any guidance the company has given for the year ahead.

FFO is essentially a REIT’s cash flow from operations, excluding changes in the valuation of its properties. This will be tend to be less volatile than a company’s profit unless the company has sold off a large proportion of its assets in the prior year.

 

5. Tenant reliance

This metric is how reliant a REIT is on the Top 10 or so tenants for its income. Just about all REITs will tell you they have high-quality tenants. But tenants can and do move and the impact on a REIT reliant for that tenant on 20% of its income will be different to one that had that tenant at just 1% of income.

A good REIT shouldn’t have any more than 40% of its rent derived from its top 10 tenants, and preferably less.

 

 

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