Valuation 101 Would You Like a Dividend with Your Funds From - - PowerPoint PPT Presentation

REIT (Real Estate Investment Trust) Valuation 101

Would You Like a Dividend with Your Funds From Operations?

Question the Other Day….

“Help! I have to value a real estate investment trust (REIT) as part of a case study in an interview.” “How should I do it? I looked online, but all the templates and examples seem too complicated.”

The Short Answer

• Yes, REIT valuation can get complex… but you can also take an 80/20

approach and get decent results without a huge investment of time

• Point #1: You must understand the basic characteristics of REITs

before valuing them

• Point #2: You must know whether your REIT follows U.S. GAAP
• r IFRS – all other online articles ignore the differences
• Point #3: REIT Valuation is not that much different – Public Comps,

Precedent Transactions, and the DCF still work… but with a few differences and additions

Lesson Outline

• Part #1: Basic characteristics of REITs and differences in accounting

and key metrics under U.S. GAAP vs. IFRS

• Part #2: How to build a simple projection model for a REIT
• Part #3: How to extend it into a Discounted Cash Flow (DCF) or

Dividend Discount Model (DCM)

• Part #4: How to add a Net Asset Value (NAV) Model for U.S. REITs

and Public Comps for both types of REITs

Basic ic Characteristics of REITs

• A real estate investment trust (REIT) is a company that buys, sells,

develops, and operates properties or other real estate assets

• It must distribute a high percentage of Net Income in the form of

Dividends, maintain high % of Real Estate Revenue and Assets, etc.

• And: The REIT pays nothing, or very little, in corporate income taxes
• Implication #1: REITs are always maintaining, acquiring,

developing, renovating, and selling properties – project each one

• Implication #2: REITs constantly need to raise Debt and Equity

Basic ic Characteristics of REITs

• Implication #3: Buying/selling/revaluing of properties makes

Net Income fluctuate, creating the need for alternative metrics

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

Amortization + Losses / (Gains) + Impairments

• U.S. GAAP: Depreciation on the Income Statement is huge
• IFRS: No Depreciation, but REITs mark their properties to market

value and record Unrealized (Fair Value) Gains/Losses on the IS!

• IFRS: The D&A component of FFO will be 0, and Losses / (Gains)

will be much bigger

REIT FFO Calculations – U.S. GAAP vs. IFRS

• Compare the statements of Avalon Bay (U.S.-based multifamily REIT) to

Westfield (Australian retail REIT):

Basic ic Characteristics of REITs

• Adjusted Funds from Operations (AFFO): FFO – Recurring CapEx +/-

Amortization of leases/straight-line rent +/- Others (varies widely)

• Balance Sheet: RE Assets, Debt, and Equity are always huge, but

under IFRS, the RE Assets are marked to market value!

• Implication #4: Assets – Liabilities, or Book Value, is important

and useful for IFRS-based REITs, but you must adjust it for U.S. REITs

• Typical Adjustment: Apply a Cap Rate (Yield) to the REIT’s property

income to value its properties, estimate fair market value of other Assets and Liabilities, and subtract Liabilities from Assets

Sim imple Projection Model for a REIT

• Step #1: Project revenue and expenses for the REIT’s existing

(“same-store”) properties – assume rental growth and margins

• Step #2: Make assumptions for the REIT’s acquisition and

development/renovation plans, such as annual spending, an

• perating income yield on that spending, and a margin
• Step #3: Assume that the REIT also divests properties, records

Gains/Losses, and loses revenue and operating income as a result

• Step #4: Add up all the property-level revenue and expenses

Sim imple Projection Model for a REIT

• Step #5: Project corporate-level items, such as Depreciation,

SG&A, Maintenance CapEx, and Working Capital, in the traditional ways (e.g., % of revenue or expenses)

• Step #6: Make Dividends a % of FFO, AFFO, or similar metric
• Step #7: Assume Debt and/or Equity Issued based on the Cash

balance before financing vs. a minimum Cash Balance (small %

• f expenses)

Ext xtensio ion into a DCF or DDM

• Step #1: For a DCF, start by linking in the revenue, expenses, etc.

from your projection model to calculate Unlevered FCF

• Differences: Can ignore corporate taxes in most cases, but you

must include all CapEx spending and asset disposals!

• Also: Track Stock Issued if the REIT keeps issuing it continually
• Step #2: Project revenue growth, margins, D&A, CapEx, and

Asset Sales beyond the end of projections to get ~10 years total

• Step #3: Make a simple assumption for future Stock Issuances

Ext xtensio ion into a DCF or DDM

• Step #4: Calculate Terminal Value with a Terminal EBITDA multiple
• r the Gordon Growth Method, and back into Implied Equity Value
• Implied Share Price: Make sure you divide Implied Equity Value by

(Current Share Count + Estimated # of Future Shares to Be Issued)

• DDM: Similar, except you use Cost of Equity instead of WACC, use

P / FFO or variants for Terminal Value, and discount and sum up Dividends instead

• Recommendation: We still like the Unlevered DCF because it’s

easier to set up (no need to forecast interest, Debt, etc.)

NAV Model and Public Comps

• Only U.S.-Based REITs: For IFRS ones, properties values already

appropriate, so Book Value is fairly close to NAV

• First: Project the forward “Net Operating Income” (operating income

from properties) and divide by an appropriate “Cap Rate” or “Yield”

• Second: Value the other assets; small premium for Construction, set

Goodwill/Intangibles to 0, and the rest should stay about the same

• Third: Adjust the Liabilities – main adjustment is to take the fair

market value of Debt if interest rates or credit risk have changed

NAV Model and Public Comps

• Fourth: Subtract the adjusted Liabilities from the adjusted Assets to

calculate Net Asset Value (NAV), and then NAV per Share

• Public Comps: Typically screen based on Real Estate Assets,

Geography, and Sub-Industry (e.g., Hotel REITs or Retail REITs)

• Metrics: Can still calculate Equity Value, Enterprise Value, EBITDA,

EV / EBITDA, etc.

• U.S. REITs: Will also use FFO and P / FFO, and NAV and P / NAV
• IFRS REITs: Book Value and P / BV in place of NAV and P / NAV

NAV Model and Public Comps

• Finding the Data: Easiest option is to use Google Finance, look up

“Related Companies,” and pull in the basics from there:

• Projections: Can just assume simple % growth rates for EBITDA, FFO, etc.

– use projected EPS or Revenue on Yahoo! Finance and go from there

Recap and Summary

• Part #1: Basic characteristics of REITs and differences in accounting

and key metrics under U.S. GAAP vs. IFRS

• Part #2: How to build a simple projection model for a REIT
• Part #3: How to extend it into a Discounted Cash Flow (DCF) or

Dividend Discount Model (DCM)

• Part #4: How to add a Net Asset Value (NAV) Model for U.S. REITs

and Public Comps for both types of REITs