7 Features of REITs

This is chapter two of a guide
to REIT stocks. Begin here.

This is chapter two of a guide on REIT investing. Begin here.

Experience this guide your way

Download the entire guide as PDF to read and reference at your own pace.

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

REITs are exempt from paying federal taxes

One way to view this feature is to say that Uncle Sam, who has a senior claim on the profits of all publicly-traded companies in the U.S., has forfeited his right to tax for the benefit of the REIT shareholder.

Another way to view this feature is to note that for $100 of taxable earnings, the typical common shareholder is left with $42 after-tax. While for $100 earned by a REIT, the shareholder is left with $60 after-tax.

REITs are required to distribute at least 90 percent of their taxable earnings

This feature is appealing to investors who are looking for a steady and stable income from their portfolio of stocks. If you observe the last 30 years, you will see that equity REITs’ dividend yield average was 6 percent and even reached double digits return in both 1989 and in the period between 2007 and 2009.  

As a point of reference, the S&P 500 earnings yield ranged from between 2% to 4% during that time.

REITs lure the dividend yield-seeking investors

Because of the prior two features, people in retirement, who often look for a stable source of cash flow, find the world of REITs appealing.

REITs charm retirees because people can understand how real estate works, especially if they have had experience in real estate ownership.

Secondly, tracking real estate values is straightforward. A basic understanding of occupancy trends, market rents and contractual leases is within everyone’s circle of competence.

Estimating future earnings of a REIT is easier than estimating the earnings of a typical publicly-traded firm

Whether a drug will be approved by the FDA or whether the United States Department of Justice will allow a merger acquisition is uncertain. But REITs life depends on contractual leases that often expire in future years. So, to have a rough range of future earnings based on the historical growth trends is a reasonable task to master.

Consider Kimco Realty Trust (KIM) as an example. Revenue was $759 million in 2008 and $922 million in 2012, amounting to a 4% compound annual growth rate.

With that number in mind, pull your HP12C and guess what is the 2017 revenue? you get $1,121 million. And, in fact, KIM revenue was $1,201 million during that year.

Because the operating expenses to revenue ratio hardly changes for a well- operated REIT, the same analysis can be applied to find the net earnings.

REITs sell stock often

Just writers ask what is the purpose of each sentence, the REIT investor must keep track of the REIT's financial performance. The reason REITs often visit investment bankers is because REITs cannot retain earnings to fund future growth. Instead, it must either (1) borrow money or (2) issue more stock. So, the REIT investor, who will evidently see a dilution in the equity position, must ask if the increase in market value warrants the dilution.

Using Kimco Realty again as an example, we see that in 2008 there were 259 dilutive outstanding shares, and at the end of 2017 there were 424 million, a compound growth in outstanding shares of about 5%.

Yet the compound growth in earnings per share was about 1%. In 2008 the company earned $0.78, and in 2017 the company earned $0.87. A rule of thumb of investing is that when the dilutive shares exceed the growth in earnings per share, the stock price is hurt.

Unsurprisingly, KIM traded between $30 and $18 in 2008 and is now trading at $16 per share.

REITs are highly sensitive to capital markets

There is a co-dependent relationship between the management of a REIT and its lenders. Management, whose main goal is to increase shareholder value by growing earnings, is highly dependent on the willingness of lenders to lend.

By explicitly purchasing a REIT stock, you implicitly assume a lender will finance the REIT's future operations.

Not much difference between asset classes

The 25-year CAGR annual return for the FTSE NAREIT ALL REITs Index was 12.1% between 1990 and 2015. During this time, office properties returned  13.1%, industrial properties returned 12.2%, retail properties returned 14.1% and hotel properties returned 10.5%.

The difference in return among asset classes was less than 15%. That implies, to me at least, that in terms of expected return, no asset class is absolutely superior to the another asset class.