Real Estate Investment

Trusts (REITs) 101: The

Crash Course
Would You Like a Dividend with Your Funds
From Operations?
Lesson Outline
• Topic #1: What Are REITs, and Why Do They Exist?

• Topic #2: Categories of REITs

• Topic #3: REIT Financial Statements

• Topic #4: REIT Key Metrics and Ratios

• Topic #5: REIT Valuation

What Are REITs, and Why Do They Exist?
• A real estate investment trust (REIT) is a company that buys, sells,
develops, and operates properties or other real estate assets

• Like a private equity firm, but for properties rather than normal
companies

• But: This description could match many companies – real estate

operating companies, real estate private equity funds…

• REITs: Similar operations to those other entities, but special

requirements and attributes that set them apart and change their
accounting and valuation!
What Are REITs, and Why Do They Exist?
• Requirement #1: Must distribute a high percentage of Net Income
as Dividends (90% in the U.S. / HK / Germany; 95% in Brazil /
Mexico; 75% in South Africa; 100% in some countries!)

• Requirement #2: A high percentage of Revenue must be from

RE-related sources (75% in Canada / Germany / South Africa; 80%
of earnings ex-capital-gains in Spain; 75% of profits in U.S. and U.K.)

• Requirement #3: A high percentage of Assets must be RE-related

(75% in the U.S. / U.K. / HK; 70% in Japan; 80% in India)

• And: Others for leverage, capital, foreign investments, legal side, etc.
What Are REITs, and Why Do They Exist?
• Why Bother? If a REIT complies, it incurs no corporate taxes (or
greatly reduced corporate taxes…)

• Idea: REITs let “normal people” invest in a broad selection of

properties, and the investors are taxed only as individuals

• But: Paying out such a high % of Net Income also means that
REITs must raise Debt and Equity constantly since they can’t save
up much to fund acquisitions, developments, etc.

• Also: Constant buying/selling/revaluing of properties makes

Net Income fluctuate, creating the need for alternative metrics
Categories of REITs
• REIT Structure: Traditional (own assets directly) vs. UPREIT vs.
DownREIT (“Operating Partnerships” that own/manage properties)
– good to know, but not important for modeling/valuation purposes

• REIT Strategy: Equity (own properties) vs. Mortgage (invest in RE

loans) vs. Hybrid (mix of both)

• REIT Sector Focus: Office/Industrial/Retail vs. Single-Family vs.

Multifamily vs. Hotels vs. Storage vs. Data Center vs. Specialized

• Our Focus: Equity REITs that own Office/Industrial/Retail,

Residential, and Hotel properties – and maybe a few others
Categories of REITs
• Mortgage REITs: Relatively few exist, even in the biggest market
(the U.S.), and they’re more similar to commercial banks – see the
Bank Modeling course!

• Others: As with individual properties, most “other” REITs fall into

one or more of the main categories

• Healthcare: Mix between multifamily (e.g., elderly housing ) and

office REITs

• Student Housing: Similar to multifamily (~1-year, non-customized

leases, dozens/hundreds of tenants)
REIT Financial Statements
• Equity REIT Operations: Maintain/Raise Rents; Acquire,
Develop, Renovate/Redevelop, and Sell Properties

• And: They issue huge Dividends each year, so they need to raise
Debt and Equity constantly to fund their operations

• So: Each action above corresponds to one or more major line items
on a REIT’s financial statements

• Also: Big line items for Depreciation, Interest Expense, and

Gains/Losses (some of these are region-specific – be careful!)
REIT Financial Statements
• Maintain/Raise Rents: Rental Income, Operating Expenses, and
Property Taxes on IS; Net Real Estate Assets on BS

• Acquire/Develop/Renovate Properties: Net Real Estate Assets on

BS and the big line items in Cash Flow from Investing on CFS

• Sell Properties: Proceeds from Sales in CFI on CFS, Gains/Losses

on IS and CFS, and Discontinued Operations

• Dividends, Debt, and Equity: Big line items in CFF section of CFS

• Other: Most other line items relate to “corporate overhead” expenses

REIT Financial Statements
• Depreciation: Skipped this for individual properties since we ignored
taxes – but REITs must record it, and it reduces taxable income

• BUT: Only for U.S.-based REITs! REITs that follow IFRS do not
depreciate property (so all D&A relates to other assets)

• Because: REITs that follow IFRS mark their properties to market

value instead of listing them based on historical cost and depreciation

• So: Massive “Fair Value Gains and Losses” on the statements of

non-U.S. REITs instead of the big Depreciation line item
REIT Financial Statements
• Gains and Losses: All REITs record Realized Gains and Losses (i.e.,
they sell the property above or below its book value)

• But: REITs that follow IFRS also report Fair Value Gains and Losses
since they’re constantly revaluing properties – even without sales

• All Gains and Losses are non-cash and adjusted for on the CFS

• Balance Sheet: Assets – Liabilities is useful for IFRS-based REITs,

but you must make significant adjustments for U.S.-based REITs

• Interest: Huge line item for REITs; Preferred Dividends also common
REIT Key Metrics
• Metrics: Figures like EBITDA, Net Income, Revenue Growth,
Margins, etc. still apply… but we also have some new metrics!

• Funds from Operations (FFO): Net Income + RE Depreciation &

Amortization + Losses / (Gains) + Impairments

• Purpose: Version of Net Income that removes large, non-recurring

items and large but irrelevant line items – often close to the REIT’s
Cash Flow from Operations

• U.S. GAAP vs. IFRS: Proportional split differs, but calculation is

the same
REIT FFO Calculations – U.S. GAAP vs. IFRS
• Compare the statements of Avalon Bay (U.S.-based multifamily REIT) to
Westfield (Australian retail REIT):
REIT Key Metrics
• Adjusted Funds from Operations (AFFO): FFO – Recurring CapEx +/-
Amortization of leases/straight-line rent +/- Others (varies widely)

• Purpose: Better reflects ongoing CapEx requirements, but also very

arbitrary, and many REITs don’t even list it

• Net Operating Income (NOI), Cap Rates, and Occupancy Rates:

Like the ones for individual properties, but calculated for the REIT
as a whole – also look at Cap Rates implied by share prices

• Dividends, Yields, and Payout Ratios: Important for evaluating REITs

vs. peers (variations such as Distributable Income in Singapore)
REIT Key Metrics
• Weighted Average Lease Expiry (WALE): % Rental Income or
Rentable Area * Remaining Term in Lease Across All Leases

• Purpose: How much income protection does the REIT have? Lower
values mean more lease expiration risk, but higher values might be
worse if market rents rise rapidly!
REIT Key Metrics
• Credit Stats and Ratios: Debt / EBITDA, EBITDA / Interest, etc.

• “Gearing”: Total Debt / Total Equity or Total Debt / Total Assets

• Why: Tie into REIT requirements in some countries, and measure risk

• Why 2: Helps you evaluate whether a REIT should raise Equity or

Debt to fund its operations (Debt is almost always cheaper at first, but
the REIT can only use so much of it)
REIT Valuation
• Public Comps and Precedent Transactions: Same idea, but
different metrics and multiples under U.S. GAAP and IFRS

• Both: Equity Value and Enterprise Value, NOI, Cap Rates,

Total RE Assets, EV / EBITDA, and Implied Cap Rates

• U.S. GAAP: FFO, AFFO, and P / FFO and P / AFFO multiples

• IFRS: BV and P / BV far more common since properties are marked

to market value; FFO, if it is used, is calculated differently; more
emphasis on Net Income, Distributable Income, Dividends, etc.
REIT Valuation
• Intrinsic Valuation: The Discounted Cash Flow (DCF) and Dividend
Discount Model (DDM) models still apply

• DDM: Very relevant for REITs since they must pay high Dividends
each year to maintain their “no corporate taxes” status

• New One: The “Net Asset Value” (NAV) Model, where you calculate
the market value of all the REIT’s Assets and subtract the market
value of all its Liabilities (similar to a Liquidation Valuation)

• IFRS: Pretty boring/simple because the Balance Sheet should

already be marked to market – might see only minor adjustments
REIT Valuation
• U.S. GAAP: NAV is more involved and requires multiple steps

• Step 1: Project 12-month forward NOI for the REIT (or by segment)

• Step 2: Apply a Cap Rate to calculate the Market Value of RE Assets

• Step 3: Project and apply (higher) Cap Rate to non-rental-income

• Step 4: Add Steps 2 and 3 to all other Assets (w/ minor adjustments)

• Step 5: Subtract all Liabilities (and Preferred Stock/NCI)

REIT Valuation
• Step 6: Divide this “Net Asset Value” by the REIT’s share count to
determine NAV per Share; compare to its current share price

• IDEA: The NAV Model assumes that there are pricing discrepancies
between local real estate markets and the stock market

• Local Markets: Cap Rates might shift more quickly, creating

arbitrage opportunities

• Uses: Can also create a P / NAV multiple and use it in Public Comps
(and under IFRS, it’s even easier)
Recap and Summary
• Topic #1: What Are REITs, and Why Do They Exist?

• Topic #2: Categories of REITs

• Topic #3: REIT Financial Statements

• Topic #4: REIT Key Metrics and Ratios

• Topic #5: REIT Valuation