In this tutorial, you’ll learn how REITs operate, how to create simple 3-statement projection models for them, how to extend the projections into a DCF analysis, and how to complete a Net Asset Value (NAV) model and use Public Comps to value a REIT.
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Table of Contents:
2:14 Part #1: Basic Characteristics of REITs and U.S. GAAP vs. IFRS
6:17 Part #2: Simple Projection Model for a REIT
12:00 Part #3: Extension of the Projection Model into a DCF for a REIT
16:03 Part #4: Net Asset Value (NAV) for REITs and Public Comps
19:40 Recap and Summary
To value REITs simply and effectively, you must understand how they operate, their special requirements, and the differences between U.S. GAAP-based and IFRS-based REITs.
REITs buy, sell, develop, and operate properties or other real estate assets. They must distribute a high percentage of Net Income in the form of Dividends (90% in the U.S.), and high percentages of their revenue and assets must come from real estate.
In exchange, they pay no corporate income taxes (or greatly reduced corporate taxes).
REITs are always maintaining, acquiring, developing, renovating, and selling properties, and since they distribute so much Cash, they constantly need to raise Debt and Equity to operate.
The Gains and Losses on property sales make Net Income fluctuate, so you look at alternative metrics, such as Funds from Operations (FFO) or EPRA Earnings, when analyzing REITs.
Funds from Operations (FFO) = Net Income + RE Depreciation & Amortization + Losses / (Gains) + Impairments.
Under U.S. GAAP, REITs depreciate properties and record a huge Depreciation expense on the IS; under IFRS, they revalue properties constantly and record huge Fair Value Gains and Losses instead.
Also as a result of that, Book Value is important and meaningful for IFRS-based REITs but must be adjusted significantly for U.S.-based REITs.
To project a REIT’s statements, you start by projecting its “same-store” (existing) properties by assuming rental growth and margins.
Then, assume acquisition, development/redevelopment spending, a yield on spending, and margins there, and assume something for dispositions and the lost revenue and operating income.
Add up all the property-level revenue and expenses, and then project corporate items such as Depreciation, Maintenance CapEx, and SG&A with traditional percentage approaches.
Make Dividends a % of FFO, AFFO, or EPRA Earnings, and assume Debt and Equity issued based on the REIT’s Cash before financing vs. its minimum Cash balance.
To value a REIT with a DCF, extend these projections, factor in all CapEx and Asset Sales, as well as Stock Issued, and project revenue, margins, D&A, CapEx, and Asset Sales through a 10-year period.
Calculate and discount Terminal Value the normal way, discount and sum up the Free Cash Flows, back into the Implied Equity Value and divide by the share count (current + future shares to be issued) to get the Implied Share Price.
The DDM is similar, but you use Cost of Equity instead of WACC, Equity Value-based multiples for the Terminal Value, and you discount and sum up Dividends rather than Unlevered FCF.
To calculate NAV for U.S.-based REITs, project the 12-month forward Net Operating Income from properties, divide it by an appropriate Cap Rate or Yield (based on similar transactions or companies in the market), and then take the market value of the other assets and add them up.
Then, adjust the Liabilities, and subtract them from the market value of Assets to determine Net Asset Value; divide by the share count to get NAV per Share and compare it to the Current Share Price.
Public Comps are similar, but the screening criteria are usually Real Estate Assets, Geography, and Sub-Industry. You can use traditional metrics and multiples like EBITDA and EV / EBITDA, but you’ll also use alternative ones such as FFO, P / FFO, NAV, and P / NAV, and, for IFRS-based REITs, Book Value and P / BV.
To find the data, you can use “Related Companies” on Google Finance, get the assumed growth rates for the projections from sources like Yahoo Finance, and go from there.