Most investors don't have the time to do that type of analysis, so the easiest thing to look at is AFFO or FFO (funds from operations) and payout ratios based on AFFO and FFO. All REITs report FFO, and it is generally the standardized calculation defined by RealPAC, whereas not everyone reports AFFO.
What's been happening with distributions?
Historically, everyone has distributed as close to 100 per cent as they could. Most will tell you that they're "targeting an 85-95 per cent AFFO payout ratio," but most are distributing close to 100 per cent. Now at times like this, when we are emerging out of a sharp recession, some REITs end up distributing more than 100 per cent of their AFFO.
Does the payout ratio really matter?
Yes, it does. You want to see something below 100 but also have to keep in mind that if someone is over distributing, that doesn't necessarily mean they'll cut. Instead, they may deprive you of distribution growth for next two years while they grow into their distribution. But in that case, you need to see a credible plan to grow free cash flow. If you're paying out 120 per cent of AFFO and your properties are 99 per cent occupied, how are you going to generate any incremental free cash flow? You're left with a problem: Pray for recovery or cut the distribution.
"They have triple-A trophy assets in markets like Toronto, Ottawa and Manhattan. Their assets are second to none, they have a great management team and a very low payout ratio. Low leverage, too. We think it's worth $18, and it's trading at $14.09."
"This is a cost of capital trade. They can acquire properties at 8 to 13 per cent cap rates and they can finance them with CMHC insured debt at 4 per cent-plus right now. That is a huge spread. I think it's worth $8.25 and it's trading at $7.30 right now."
"It has a huge exposure to Calgary and that's a bit of an overhang, but their buildings are still 95 per cent occupied. They also actively diversified out of Calgary by buying offices in Toronto and Ottawa as well as some industrial. We think it is worth $27, and it's trading at $24.57."
A REIT primer
Why invest in a real estate investment trust?
REITs buy and sell properties, giving investors a passive way to own real estate. They also pay cash distributions.
Net asset value (NAV)
Values of all assets, minus the debt.
Funds from operations (FFO)
Comparable to earnings per share for stocks, this measures a REIT's profitability. Or lack thereof.
Adjusted funds from operations (AFFO)
A more precise measure of profitability that strips out one-time capital expenditures.
The amount of money a REIT pays its unit-holders, relative to how much it earns. A lower ratio means it is hanging on to its cash; ratios close to 100 per cent could mean the distribution is in peril of being reduced.
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