How to pick a good REIT
How I Pick the Best Investment Trusts (REITs)
Along with real estate crowdfunding, I regularly invest in Investment Trusts (REITs), which are companies that solely obtain income from property investments. In this article, I will share generate an income select the best REITs for my digital property portfolio.
We will have that even if REITs share a lot of common functions with other dividend paying stocks, they have their own specificities as it’s also a method to invest in property. We will see the different criteria that I use for my own portfolio when purchasing a REIT. Let’s dive in!
Dividend Yield & Dividend History
The very first thing I do when selecting a REIT is quite similar as to the I would do with any dividend paying stock: look in the dividend yield & dividend history. This is not a website about dividend growth investing (for more information on this topic, I suggest looking at my other web site, Dividend Academy), but I will just give you a summary here of what I am looking at.
You first possess the dividend yield. This is the current annual yield of the actual investment. Usually, the yield of a REIT will be greater than other dividend paying stocks, as a REIT needs to distribute the majority of its profits as dividends. I usually look for REITs along with yields around 5 or 6%, which are a bit less than my other real estate investments.
Then, I look at the actual REIT dividend history. This is really important, as you want to purchase a REIT that has a good history of paying returns. What is even more important is that the REIT has growing dividends with time, meaning that the company cares about its shareholders, and also that the dividend payouts will maintain inflation.
Financials & Funds From Operations (FFO)
Just like any other investment in a business, I then look in the financials of the company. You can look at the typical gross revenue, expenses and profits, but for a REIT there’s another metric that is more important than profits: the money from operations, or FFO.
Indeed, as a company deriving the majority of their profits from real estate, a REIT will usually count depreciation and amortisation of the portfolio to their earnings, meaning a lower profit on the total amount sheet. But what we really want to look at is actually their funds from operations, which is the ‘real’ cash flow from the company obtained by adding depreciation & amortisation to their income. This is the metric that I look at when picking out a REIT, and comparing REITs between each other.
Type of Home Owned
Next, I look at the type of property that is owned by the REIT I wish to invest in. Indeed, investing in REITs is a fantastic method to diversify your property portfolio in sectors that wouldn’t be accessible for you otherwise, like healthcare real estate, or large retail properties like departmental stores.
I also like to use REITs to invest in really specialised property, like I did with a company called DLR (Electronic Realty Trust Inc), which is a company that purchase real estate dedicated to hosting computer servers. I think is an excellent sector that will have a strong growth in the long term, and unless you have millions of dollars to invest, this sort of investment is only accessible via a REIT.
Geographical Location
I also take a look at where the property portfolio of the REIT is located, to see if it can diversify my investment portfolio geographically. Indeed, it’s really easy to invest abroad when utilizing REITs: usually, you will have access to a wide selection of stock exchanges from the broker that you’ll use to invest in REITs. In a few clicks, you can invest virtually anywhere in the world.
Therefore, even if most of my REITs investments are located in america, I have some of them where I live at as soon as (in Europe), but also in Hong Kong or even Singapour. I really like to use REITs to diversify my portfolio all over the world, as it’s nowadays so easy to do so.
How about REITs ETFs?
Finally, I wanted to end this article along with another consideration when selecting REITs: what about REITs ETFs? While you might know, ETF stands for Exchange Traded Fund, which is really a mutual fund composed of several positions, but that you can purchase on the stock market just like another stock.
There are indeed ETFs available that are solely composed of REITs. I have some during my portfolio, that I bought when I started investing in dividend having to pay stocks. However, I really recommend selecting good REITs yourself rather, rather than relying on an ETF that will have a broad selection of REITs inside it.
These were the criteria which i use personally when investing in REITs.
AFFO: The only metric which matters
In most industries, net income is a good way of measuring profitability. But this isn’t the case with REITs because of 1 line item – depreciation. In almost any other business, assets need replacing and this must be reflected in the company’s financial outcomes. But real estate, in contrast, will rarely lose its worth.
When assessing the performance of a REIT, the No. 1 metric experts use is adjusted funds from operations, or AFFO. This figure is merely net income plus depreciation, less gains from asset sales as well as less capital expenditures. AFFO is the single best gauge of residual income to unitholders. It’s also the best way to determine a trust’s capability to finance its debt and pay dividends.
In the case associated with RioCan, we can use the AFFO to highlight one red-colored flag: the trust is actually paying out more cash to unitholders than it’s generating. In 2012, RioCan generated $0. 34 per unit within AFFO but paid $0. 345 per unit in distributions. That’s not really a large deficit, but it could limit the firm’s ability to raise distributions later on.
Growth prospects
Next, you want to evaluate the attractiveness from the company’s assets. There’s no magic metric to turn to in this instance. Only a careful analysis of the trust’s underlying business.
Do you know the prospects for rent increases? What are the prospects to enhance occupancy rates? Does management have a plan to upgrade it’s assets? Often, management teams will acquire low-end properties and improve these phones attract higher-quality tenants. Better tenants lead to higher occupancy prices, fewer evictions, and higher rents.
You want to have a good sense in regards to what types of properties the trust owns. Residential? Commercial? Industrial? Exactly where are they located? Vancouver? Toronto? Montreal? A commercial trust in Calgary is subjected to a very different set of risk factors than a residential rely upon Halifax. Who are the tenants? Can they pay? It’s time for you to think like a landlord.
You’ll also need to be looking for tricks management might use to beef up financial results. Frequently, executives will delay needed repairs – a shortsighted move that’s a really hidden liability.
RioCan is actually well-positioned to grow its AFFO within the next few years. With 350 retail properties across the region, more than 85% of the company’s revenue comes from nationwide and anchor tenants like Wal-Mart, Target, Canadian Tire, and Staples. With around 45% of leases due for renewal over the next 5 years, RioCan should be able to pass on some lease increases. That could mean higher distribution payout for unitholders.
Who’s operating the show?
A simple way to think of a REIT is really as a real estate mutual fund. Investors pool their money together and hire a manager to purchase, manage, and sell assets. Obviously, the performance of the account, like any business, will be determined in large part through the people who run it.
When evaluating a trust, you want to closely evaluate the history of the management team. How much experience do they have? What’s their track record?
Equally important is to look at exactly how executives are compensated. You want to make sure management’s incentives are aligned using the unitholders. Does the chief executive own many units? If the fund isn’t good enough for portfolio, it probably doesn’t belong in yours.
One look in the stock chart is probably enough to convince you that Ed Sonshine has been doing a good job as head of RioCan. Over the past two decades, RioCan has generated a 15% annualized return. Sonshine is also a very respected figure in the Canadian real estate industry.