Real estate investment trust (REITs) are a popular investment choice among income investors. The income which is derived from the rental of a REIT’s properties is paid out of investors in the form a distribution (similar to dividends for companies). To be listed as a REIT, the REIT’s manager is required to pay-out a minimum of 90% of its taxable income to investors.
Let’s have a look at two metrics which investors can use to quickly determine if a REIT is worthy of further investigation.
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For any REIT, the book value (or net asset value) is a good indication of whether an investor is overpaying or underpaying for the properties held by the REIT. The book value is derived by dividing the REIT’s equity by the number of units outstanding.
Let’s look at a simple example for a better understanding. If a REIT has a book value of S$1, this means that if it were to sell all its assets, investors would theoretically get back S$1. This also means that if investors can buy units of the REIT for under S$1, they are getting a bargain. This is because they are paying less then what the assets are worth.
A REIT that has a unit price of S$0.90 and a book value of S$1 would imply a price-to-book value of 0.9. In other words, investors are getting S$1 worth of assets for only S$0.90. However, the opposite also holds true, if an investor pays more than the book value, he might be overpaying for the assets.
The second metric is the distribution yield (or dividend yield for companies). Because REITs are required to pay out a minimum of 90% of taxable income, the distribution yield might be a good indicator of value. If we assume that a REIT’s assets produce a rather stable income stream year over year, the only other factor that affects the yield is the REIT’s price on the market.
For example, if a REIT pays out a consistent distribution of 5 cents a year and its units price is currently S$1, this means investors are getting a 5% yield. However, if the unit price now drops to S$0.90 the yield has increased to 5.6%.
The above example demonstrates that investors can look at the consistency of distribution payouts by the REIT over the past five to ten years. This then allows them to determine the highest and lowest distribution yield the REIT offered over this period. Comparing those yields to the current yield would allow investors to get a reasonable understanding of whether the REIT is over-valued or under-valued.
To sum up, investors can quickly assess if a REIT is attractively priced by using just two metrics which are often easily found. If these two metrics show a compelling picture, it might make sense to dig in deeper into the REIT.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.