How do I Invest in a REIT?
An individual may invest in a stock exchange-listed REIT, which is listed on major stock exchanges. Investors may also purchase shares in a REIT mutual fund or exchange-traded fund (ETF). A broker, investment advisor or financial planner can help analyze an investor’s financial objectives and recommend appropriate REIT investments. Investors also have the ability to invest in public non-listed REITs and private REITs.
Like all companies whose stocks are publicly traded, stock exchange-listed REIT shares are priced by the market throughout the trading day. To assess the investment value of REIT shares, typical analysis involves one or more of the following criteria:
- Anticipated growth in earnings per share;
- Anticipated total return from the stock, estimated from the expected price change and the prevailing dividend yield;
- Current dividend yields relative to other yield-oriented investments (e.g., bonds, utility stocks and other high-income investments);
- Dividend payout ratios as a percent of REIT FFO (see above for discussion of FFO and AFFO);
- Management quality and corporate structure; and
- Underlying asset values of the real estate and/or mortgages and other assets.
What Should I Look for When Investing in a REIT?
The market usually rewards companies that demonstrate consistent earnings and dividend growth with higher price-earnings ratios, a stock valuation metric. Thus, investors should look for REITs and publicly traded real estate companies with the following characteristics:
- A demonstrated ability to increase earnings reliably. For example, look for companies with properties in which rents are below current market levels. Such properties provide upside potential in stable markets and downside protection when economic growth slows;
- REIT management teams that are able to quickly and effectively reinvest available cash flow while also developing strategies to create new revenue opportunities. Such teams should also have the ability to consistently complete new projects on time and within budget; and
- Strong operating characteristics, including effective corporate governance procedures, conservative leverage, accepted accounting practices, strong tenant relationships and a clearly defined operating strategy for succeeding in competitive markets.
How do REITs Measure Earnings and Ability to Pay Dividends?
The REIT industry uses net income as defined under the Generally Accepted Accounting Principles (GAAP) as the primary operating performance measure. Additionally, the REIT industry uses funds from operations (FFO), a measure of cash generated by a REIT, as a supplemental measure of a REIT's operating performance.
NAREIT defines FFO as net income excluding gains or losses from sales of most property and depreciation of real estate. Since real estate is commonly believed to maintain more residual value than other forms of personal property – and because it often appreciates – many securities analysts judge a REIT's performance according to its Adjusted FFO (AFFO), which adjusts FFO for rent increases and certain capital expenditures. FFO and AFFO are used by many to gain a more accurate look at a REIT’s earnings and ability to pay dividends.
Growth in REIT earnings are typically generated by higher revenues, lower costs and new business opportunities. The most immediate sources of revenue growth are higher rates of building occupancy and increased rents. Additional property acquisition and development programs also create growth opportunities, provided the economic returns from these investments exceed the cost of financing.
REITs are increasingly a key aspect of investment portfolios and retirement savings. According to a study by economists Robert J. Shapiro and Nam D. Pham, nearly half of all publicly traded REIT shares by value are held in pension plans and retirement accounts. Public and private pension plans and 401(k)s account for 29.1 percent of REIT shares, while investors with IRAs hold an additional 18.1 percent of REIT shares.
The requirement that REITs pay out at least 90 percent of their taxable income to shareholders in the form of dividends makes them a strong income-generating investment. Additionally, as stocks, REITs also provide the opportunity for capital appreciation. This combination of investment characteristics – current income and long-term growth – makes them effective in extending the lives of retirement portfolios.