Property / REIT / Performance metrics 1 comments

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What are the performance metrics of REITs that are important? As they grow in popularity in Asia and Singapore in particular, it is worth understanding what are these important parameters.

I shall divide the metrics along two lines -- income/cashflow statement-related metrics and balance sheet-related metrics.

Income/ Cash flow statements

Funds from Operations (FFO)
FFO = Net income + Depreciation

This roughly translates to the cash flow from operations (ie.rental payments from properties held under the REIT). Depreciation is a non-cash charge and hence is added back to obtain the actual operating cashflow. This directly gives an indication of available distribution to unitholders.

Note that adjusted FFO, which includes capital expenditure (eg. to maintain and improve the existing properties) may be a better guide to actual cashflow available for distribution.

Yield:
Equals the total annual payout divided by current market price. Since REITs are primarily an income-yielding instrument in a manner similar to fixed-income instruments (ie. bonds), it is not surprising that the most important metric is similar for both. In effect, it is the inverse of PE ratios used for normal equities, with the special case that all earnings are paid out as equivalents, and with FFO (described above) being used to estimate payout instead of net income from the income statement.


Balance sheet

Net Asset Value (NAV)
Effectively equals total asset (property) value net of liabilities, easily checked from balance sheet as total equity. Also known as book value.

Property held by REITs are routinely revalued by independent valuers. Hence NAV is being revised continually. Obviously the higher the NAV, the better; especially true for asset-heavy stocks like REITs.

At the same time, it is possible to relate market value of a property from its operating income, through the use of a market capitalisation rate.
Market value = Operating Income / Capitalisation rate

Capitalisation rate is analogous to inverse of PE. It varies for different categories of properties (residential, commercial, industrial etc).

Leverage
The higher the debt-equity ratio, the more heavily geared and the higher the financial risk for a certain payout. Hence one should expect a higher yield for a more highly-geared REIT. One may also see the situation as reflecting an inability of a highly-geared REIT to expand its portfolio of assets further without raising new equity ie. there is limited further potential leveraging of existing equity.

It is difficult to tell when leverage has become excessive. It is also important to weigh the proportion of fixed versus floating-rate debt. A REIT that uses only floating-rate debt will be hurt if interest rates rise.

References:
(1) Investopedia: What are REITs?