Transcript of Chapter 23: Real Estate Investment Trusts (REITs) 1© 2014 OnCourse Learning. All Rights Reserved.
- Slide 1
- Chapter 23: Real Estate Investment Trusts (REITs) 1 2014
OnCourse Learning. All Rights Reserved.
- Slide 2
- Exhibit 1-5: Major Types of Capital Asset Markets and
Investment Products 2014 OnCourse Learning. All Rights Reserved.2
Public Markets: Private Markets: Equity Assets: Stocks REITs Mutual
funds Real Property Private firms Oil & Gas Partnerships Debt
Assets: Bonds MBS Money instruments Bank loans Whole Mortgages
Venture Debt Way back in Chapter 1
- Slide 3
- 2014 OnCourse Learning. All Rights Reserved.3 Macro-level
valuation Valuation of aggregates of numerous individual
properties, e.g., portfolios, indices, funds, REITs The spectrum of
macro-level R.E. equity investment entities: Static Portfolios,
Indices Funds Unit Trusts LPs REITs REOCs The valuation question
Static portfolios (private assets) Value estimation (measurement).
Static portfolios (private assets) Value estimation (measurement).
REITs (publicly-traded assets) Value determination (causal). REITs
(publicly-traded assets) Value determination (causal). Entity-Level
Valuation Property-Level Valuation Direct, passive investment in
property Indirect investment in property, actively-managed
entities. Ch 23 intro
- Slide 4
- 2014 OnCourse Learning. All Rights Reserved.4 What are Real
Estate Investment Trusts? Operating companies that own, develop and
manage commercial real estate Chartered as a corporation or
business trust Elective choice under tax code creates pass-through
of income Revenue must primarily come from real estate investments
Required to distribute at least 90 percent of their taxable income
Taxation of income is passed through to shareholder level 23.1:
Introduction to REITs
- Slide 5
- What Makes a REIT Different? 75 percent of assets must be
invested in: Equity ownership of real property Mortgages Other REIT
shares Government securities and cash 75 percent of revenue must
come from: Rents from real property Mortgage interest Gains from
sales of real property 2014 OnCourse Learning. All Rights
Reserved.5
- Slide 6
- 6 Exhibit 23-2 (Section 23.1)
- Slide 7
- 2014 OnCourse Learning. All Rights Reserved.7 Public REITs are
Like typical industrial/service/information companies traded on the
stock exchanges, except: Exempt from corporate income tax Exempt
from corporate income tax Restricted to real estate investment
related activities Restricted to real estate investment related
activities Restrictions on merchant building Restrictions on
merchant building Must pay out 90% of earnings in dividends Must
pay out 90% of earnings in dividends So REITs are different animals
somewhat passive (compared to other stocks), pure plays (in real
estate). So REITs are different animals somewhat passive (compared
to other stocks), pure plays (in real estate). But also different
from direct private market investment in real estate, as their
equity is traded in the public stock exchange. This imparts some
differences in risk & return behavior, as well as some lead/lag
relationship in price discovery, caused purely by the differences
in the functioning (and clienteles) across the two asset market
arenas (private vs public). Creates liquidity. Enhances ownership
by small passive investors w/out special expertise or
knowledge.
- Slide 8
- Exhibit 7-1: UNDERLYING ASSETS vs INVESTMENT PRODUCTS, an
Example from traditional corporate finance: 2014 OnCourse Learning.
All Rights Reserved.8 Underl. Asset: Invest. Products: Invest.
Product: Invest. Products: ABC Widgets Corporation (Collection of
Physical, Human, & Legal Assets & Relationships) ABC Common
Stock (Subordinated claims) - Moderate Risk - Moderate Total Return
- Low Cur.Yield ABC Corporate Bonds (Senior claims) - Low Risk -
Low Total Return - High Cur.Yield Call Options on ABC Stock
(Contingent claims) - High Risk - High Total Return - Zero
Cur.Yield Various Mutual Funds (owning various different types of
claims on ABC & other assets) - Various Risk, Return, &
Cur.Yield Configurations Big-picture fundamentals in Ch 7
(sect.7.1.3)
- Slide 9
- Exhibit 7-2: A REAL ESTATE EXAMPLE of the Investment System
2014 OnCourse Learning. All Rights Reserved.9 Underl. Asset:
(Priv.Traded) Private Invest. Products: Public Invest. Products:
CMBS publicly traded securities based on a pool of mortgs
Investors: individual, institutional "Bricks & Mortar" (e.g.,
Grump Family Shopping Centers) (Rent-producing Real Properties )
e.g., Ltd Partnerships (or CREFs, Priv.REITs, etc) Own equtiy in
properties: LP Shares (units) privately held & privately traded
if at all Commercial Mortgages Senior (debt) claims: Privately held
& traded ("whole loans") REITs UPREIT Owns LP Units, Issues
publicly traded shares. (May also directly own Underl.Asset, or
Mortgs & CMBS) Small & Large Investors Large Investors
(Wealthy Individuals, Developers, Institutions) Small & Large
Investors Underlying assets directly traded in a well functioning
asset market
- Slide 10
- 2014 OnCourse Learning. All Rights Reserved.10 Public Investors
(Stockholders) Private Investors (Partnership Unit-holders) REIT
Umbrella Partnership (Operating Partnership: OP) Property
Partnership Property Partnership Property Partnership Property
TheUPREITStructure
- Slide 11
- 2014 OnCourse Learning. All Rights Reserved.11 1.Ownership
Test: Five or Fewer Rule. REIT cannot be a closely held
corporation: no five or fewer individuals may own more than 50% of
REITs stock, and there must be at least 100 different shareholders.
(Look-Through Provision enacted 1993: pension funds not limited by
the five-or-fewer rule.) 2.Asset Test: >= 75% of a REITs total
assets must be real estate, mortgages, cash, or federal government
securities, and 75% or more of the REITs yearly gross income must
be derived directly or indirectly from real property (including
mortgages, partnerships, and other REITs). No more than 20% of its
assets can consist of stock of a Taxable REIT Subsidiry (TRS).
3.Income Test: >= 75% of income from primarily passive sources
like rents and mortgage interest. Cannot be merchant builders
developing properties for quick sale, or flipping properties.
Property sales must obey: held for at least four years and the
aggregate adjusted basis of the property sold per year does not
exceed 10% of the aggregate basis of all assets of the REIT as of
the beginning of the year. 4.Distribution Test: At least 90% of a
REITs annual taxable net income must be distributed to shareholders
as dividends each year. To retain REIT tax status (dividends
deductible from corporate taxable income), REITs must continually
pass 4 tests: 23.1.1: Tax Status & Regulatory Constraints
- Slide 12
- 2014 OnCourse Learning. All Rights Reserved.12 Exhibit
23-4:
- Slide 13
- 2014 OnCourse Learning. All Rights Reserved.13 23.1.2 The 1990s
REIT Boom and Modern REIT Era Historical growth of the REIT
industry (Modern REIT Era dates from 1990s) EXHIBIT 23-3 Size of
U.S. Equity REIT Sector, 19852011 Source: Based on data from the
National Association of Real Estate Investment Trusts
(NAREIT).
- Slide 14
- 2014 OnCourse Learning. All Rights Reserved.14 Based on equity
REITs only. Magnitude of REIT market
- Slide 15
- 2014 OnCourse Learning. All Rights Reserved.15 These shares are
probably a bit larger by now. Magnitude of REITs in private CRE
market Exhibit 7-3:
- Slide 16
- 2014 OnCourse Learning. All Rights Reserved.16 Magnitude of
REITs in private CRE market Exhibit 23-1:
- Slide 17
- 2014 OnCourse Learning. All Rights Reserved.17 REIT Investors
Yield-oriented Value-oriented Small-Mid cap e.g., Green Street
Cohen-Steers Vanguard Etc Recall: Different types of investors have
different objectives, constraints, concerns, horizons,
income-vs-growth preferences, risk preferences, etc Note: This mix
has varied considerably in recent years.
- Slide 18
- 2014 OnCourse Learning. All Rights Reserved.18 REIT stock mkt
performance in the Modern REIT Era (1990-2011) Overall good record
but particularly big hit in Financial Crisis.
- Slide 19
- 2014 OnCourse Learning. All Rights Reserved.19 REITs are a
major component of the Small-Cap Value group of stocks (May benefit
some from Fama-French Factors?...) Particularly big hit in
Financial Crisis, but good recovery since. 1990-2011:
- Slide 20
- 23.2 REIT Analysis & Valuation Dividend Discount or DCF
Models Share price equals PV of expected future dividends Earnings
Multiple Shortcuts to DCF earnings/cash flow Share price equals a
multiple of REIT earnings/cash flow Premium to Net Asset Value
(NAV) of a REITs Properties publicprivate Build an estimate of
public REIT equity value starting with the private mkt value of a
REITs assets in place, then adjust for growth opps and other
factors. Share price equals a warranted premium (or discount) to
REIT NAV REIT shares are valued in the same way as other public
equities, but with a twist because of the unique Real Estate asset
base REITs viewed as operating companies like other publicly-
traded firms The three approaches are certainly related, but may at
times provide different indications of value, depending on the
general economic environment as well as conditions in the public
stock and bond markets, and the private real estate market. 20 2014
OnCourse Learning. All Rights Reserved.
- Slide 21
- 21 23.2: REIT Analysis & Valuation Its all about valuation,
and fundamentally there are two ways to value a REIT: 1.As a
collection of assets; 2.As a stream of cash flows. Property
acquisition requires consideration from both perspectives.
- Slide 22
- 2014 OnCourse Learning. All Rights Reserved. 22 23.2.1: REIT
Earnings Measures. Exhibit 23-5: *Direct property EBTCF is not
directly available to a passive investor, whereas REIT AFFO is.
EXHIBIT 23-5 Widely Used Direct Property vs. REIT Income
Measures
- Slide 23
- Widely Used Direct Property vs REIT Income Measures 2014
OnCourse Learning. All Rights Reserved.23 *Direct property EBTCF is
not directly available to a passive investor, whereas REIT AFFO is.
EXHIBIT 23-5 Widely Used Direct Property vs. REIT Income Measures
PGI straight-lined in GAAP accrual accounting used by REITs, not
cash flow. OE includes prop mgt & other items that may be
profit centers for some REITs FFO typically excludes extraordinary
items such as major asset sales. Also adjust for other non-
cash-flow effects such as rent straight-lining.
- Slide 24
- 2014 OnCourse Learning. All Rights Reserved.24 On avg REITs pay
out 73% of FFO in dividends. Lately a bit less
- Slide 25
- 23.2.1 REIT Earnings Measures The Problem: How to compare REIT
earnings with those of other corporations (e.g., so as to compare
share price/earnings multiples on an apples vs apples basis. Real
estate investment & ownership (the REIT business) is very
capital intensive: Real estate investment & ownership (the REIT
business) is very capital intensive: REITs have abnormally high
depreciation expenses, which reduce official earnings (GAAP net
income), the standard measure of corporate earnings on Wall Street.
REITs have abnormally high depreciation expenses, which reduce
official earnings (GAAP net income), the standard measure of
corporate earnings on Wall Street. Yet REIT assets do not actually
depreciate in the sense that same- store property cash flows and
values typically do not decline in nominal terms (because the real
depreciation rate in property is typically matched or even exceeded
by the general monetary inflation rate). Yet REIT assets do not
actually depreciate in the sense that same- store property cash
flows and values typically do not decline in nominal terms (because
the real depreciation rate in property is typically matched or even
exceeded by the general monetary inflation rate). Hence (so the
argument goes): GAAP earnings dont present a fair or accurate
measure of REIT earnings. 25 2014 OnCourse Learning. All Rights
Reserved.
- Slide 26
- In the early 1990s, the REIT industry (through NAREIT) came up
with an alternative measure of earnings that the industry tried to
promulgate as a substitute for GAAP net income for the REIT
industry: Funds From Operations FFO FFO (Funds From Operations)
GAAP net income, then Start with GAAP net income, then Add back:
Real property depreciation expense. Add back: Preferred stock
dividends and distributions to OP unit- holders. Deduct: Net gains
from property sales & extraordinary items. FFO Aggregate (i.e.
firm level) NOI - interest 26 2014 OnCourse Learning. All Rights
Reserved.
- Slide 27
- This was further supplemented by another measure that more
closely reflected cash flow actually available for external
distribution: Adjusted Funds From Operations AFFO AFFO (Adjusted
Funds from Operation) aka Funds Available for Distritution (FAD)
Start with FFO, then: Deduct: Recurring capital improvement
expenditures (CI). Adjust for: Straight-line rents. Deduct:
Amortization of debt principle (AMORT). Terminology Alert! In
common parlance it is often not clear exactly what measure is being
referred to when people use the terms FFO and AFFO. AFFO Aggregate
(i.e. firm level) EBTCF 27 2014 OnCourse Learning. All Rights
Reserved.
- Slide 28
- FFO is often spoken of as the analogy at the REIT level of the
NOI at the property level. But what is an important difference
between these two measures of earnings? FFO is a firm-level measure
that is net of interest payments on the REITs debt. NOI is a
property-level measure that is free and clear of debt. AFFO is the
firm-level analog to the EBTCF (Equity Before-Tax Cash Flow)
measure at the property level. Typical P/E ratios based on AFFO
have varied between 8 and 12 in recent years for most REITs, while
dividend yields have averaged 6% to 8%. A simple (and somewhat
simplistic) method of REIT valuation of a property acquisition
would be to compare the property price / EBTCF multiple (based on
the REITs target capital structure debt applied to the property)
with the REITs current stock market share price/earnings multiple
based on AFFO. If the latter exceeds the former, the acquisition
may seem feasible (and/or accretive if the REIT multiple exceeds
the property multiple). However, you are more sophisticated than
this simplistic approach, arent you! 28 2014 OnCourse Learning. All
Rights Reserved.
- Slide 29
- Problems with FFO, AFFO, etc., The principle underlying The FFO
Movement is valid: Cash flow matters more than accounting numbers.
For all its faults, GAAP net income has the one great advantage
that it is uniformly and precisely defined, the same for everyone.
However, in practice several problems arose with the use of FFO:
The REIT industry could never agree on a single, mandatory standard
definition of how to define and measure FFO (or AFFO, or any of the
other cash-oriented earnings measures). The REIT industry could
never agree on a single, mandatory standard definition of how to
define and measure FFO (or AFFO, or any of the other cash-oriented
earnings measures). There arose a profusion of different measures
and definitions, with each REIT tending to customize its own
measure (e.g., REITs that made substantial money from property
sales didnt like FFOs removal of extraordinary earnings due to
asset sales; they said their operations included asset sales).
There arose a profusion of different measures and definitions, with
each REIT tending to customize its own measure (e.g., REITs that
made substantial money from property sales didnt like FFOs removal
of extraordinary earnings due to asset sales; they said their
operations included asset sales). There was a substantial loss in
credibility (based perhaps more on perception than reality), which
was exacerbated with the general corporate Pro-Forma Earnings
Scandal of the early 2000s, associated with the stock market crash.
There was a substantial loss in credibility (based perhaps more on
perception than reality), which was exacerbated with the general
corporate Pro-Forma Earnings Scandal of the early 2000s, associated
with the stock market crash. 29 2014 OnCourse Learning. All Rights
Reserved.
- Slide 30
- 30 23.2.2 Valuing REITs as a Stream of Cash Flows: the Gordon
Growth Model The Stock market is highly integrated. REIT equity
shares are traded in the stock market. So REITs are valued
essentially like other stocks (DCF, Ch.10): DIV = Annual entity
(firm) level equity cash flow to stockholders (Dividends). r =
Stock Mkts required ex ante total return to firm-level equity
(REITs avg equity cost of capital COE). PV = Value of REITs equity
(per share stock price). More common short-cut is: Gordon Growth
Model (GGM) (Based on forward-looking long-run average r and g.) g*
= Long-run avg future growth rate in dividends. Based on
constant-growth perpetuity math formula. Analogous to cap rate in
RE, Direct Capitalization method of property valuation.
- Slide 31
- 2014 OnCourse Learning. All Rights Reserved.31 GGM REIT Value =
f ( DIV 1, g*, r ). Based on three values. DIV 1 PBTCF DS G&A
plowback (holdings & sales, less plowback) = EBTCF G&A
plowback = AFFO plowback : = EBTCF G&A plowback = AFFO plowback
: Analyze firms current property operations & financing.
Analyze firms current property operations & financing. Firm can
temporarily pay out more cash than it earns from operations by the
use of sales of its assets or by the use of financing techniques,
but GGM requires long- run average values (avoid or stabilize
extraordinary sources of dividends). Firm can temporarily pay out
more cash than it earns from operations by the use of sales of its
assets or by the use of financing techniques, but GGM requires
long- run average values (avoid or stabilize extraordinary sources
of dividends). g* is very important ( 1 pt g* > 20% PV ).
Reflects: LR growth in EBTCF (sustainable same store growth(as
levered) + plowback). LR growth in EBTCF (sustainable same store
growth(as levered) + plowback). LR ability of REIT mgt to generate
growth opportunities (NPV>0 projects). This is the toughest part
(and why we add the * to the g ). LR ability of REIT mgt to
generate growth opportunities (NPV>0 projects). This is the
toughest part (and why we add the * to the g ). r = Firms avg
equity OCC = r f + RP = y + g*, in the firms equity: Based on Stock
Mkts perception & evaluation of firm-level risk. Based on Stock
Mkts perception & evaluation of firm-level risk. Two major
traditional approaches to estimate E[RP]: CAPM & GGM. Two major
traditional approaches to estimate E[RP]: CAPM & GGM. (Best
applied to a class or type of stocks, adjust for subj firms
leverage.) Most volatility in REIT prices due to changes in mkt
expectns about g* & r.
- Slide 32
- 2014 OnCourse Learning. All Rights Reserved.32 GGM REIT Value =
f ( DIV 1, g*, r ). Based on three values. r = Firms avg equity OCC
= r f + RP = y + g*, in the firms equity: Based on Stock Mkts
perception & evaluation of firm-level risk. Based on Stock Mkts
perception & evaluation of firm-level risk. Two major
traditional approaches to estimate E[RP]: 3-Factor CAPM & GGM.
Two major traditional approaches to estimate E[RP]: 3-Factor CAPM
& GGM. (Best applied to a class or type of stocks, adjust for
subj firms leverage.) Most volatility in REIT prices due to changes
in mkt expectns about g* & r. Fama-French 3-factor may enhance
DIV 1 PBTCF DS G&A plowback (holdings & sales, less
plowback) = EBTCF G&A plowback = AFFO plowback : = EBTCF
G&A plowback = AFFO plowback : Analyze firms current property
operations & financing. Analyze firms current property
operations & financing. Firm can temporarily pay out more cash
than it earns from operations by the use of sales of its assets or
by the use of financing techniques, but GGM requires long- run
average values (avoid or stabilize extraordinary sources of
dividends). Firm can temporarily pay out more cash than it earns
from operations by the use of sales of its assets or by the use of
financing techniques, but GGM requires long- run average values
(avoid or stabilize extraordinary sources of dividends). g* is very
important ( 1 pt g* > 20% PV ). Reflects: LR growth in EBTCF
(sustainable same store growth(as levered) + plowback). LR growth
in EBTCF (sustainable same store growth(as levered) + plowback). LR
ability of REIT mgt to generate growth opportunities (NPV>0
projects). This is the toughest part (and why we add the * to the g
). LR ability of REIT mgt to generate growth opportunities
(NPV>0 projects). This is the toughest part (and why we add the
* to the g ). Can be tautological; CAPM better theoretically. Also
requires serious consideration of required return
- Slide 33
- 2014 OnCourse Learning. All Rights Reserved.33 Fama-French:
CAPM by itself doesnt work very well within the stock market:22.4
The simple 1-factor CAPM has trouble empirically within asset
classes. Enhance the basic model with additional factors that are
more tangible than beta: (i) Stocks Size (mkt cap), & (ii)
Stocks Book/Market Value Ratio. The market apparently associates
these with risk. Recall from Ch.22 REITs tend to have high B/M
(HML), low Beta. Cross-sectionally, P/NAV M/B: Low P/NAV (high HML)
high return.
- Slide 34
- 2014 OnCourse Learning. All Rights Reserved.34 g = Long-run
growth rate in dividends per share (includes effect of plowback). g
E = Long-run growth rate in earnings (AFFO) of pre-existing
(same-store) assets. DIV 1 = (1-p)AFFO 1 = (1-p)y E PV 0, where p
is the plowback ratio, and : y E = equity income yield from firms
underlying asset equity [=AFFO/PV, or @ property level
EBTCF/(V-D)], PV 0 = firms underlying asset equity value at the
beginning of Year 1. Then: DIV 2 = (1-p)y E PV 1 = (1-p)y E [(1+g E
)PV 0 + py E PV 0 ] = (1-p)y E (1+g E +py E )PV 0 = (1+g E +py E
)DIV 1. g E = g py E g = g E + py E, g E = g py E. Note: For a
REIT, in the absence of growth opportunities (all acquisitions @
NPV=0), PV 0 is essentially based only on the firms assets in
place, and y E is the current equity yield of those assets. Thus, g
E is essentially the long-run growth rate insame store earnings
(same-store EBTCF as levered). GGM shortcut may be applied to
earnings rather than to dividends. And earnings may be defined in
various ways: (GAAP, FFO, AFFO,)
- Slide 35
- Analysis Tip: The GGM can be applied either to dividends or to
earnings: The firms equity OCC ( r ) is the same*, but you have to
be careful about the relevant growth rate in the denominator: g =
Long-run growth rate in dividends per share (includes effect of
plowback). g E = Long-run growth rate in pre-existing assets
earnings per share (for REITs, usually growth rate in levered same
store earnings, over the long run). Note: g E = g py E, where p =
Plowback Ratio (fraction of earnings retained for reinvestment, not
paid out as dividends: p = 1 (DIV / AFFO ). Thus, normally: g >
g E. DIV 1 = (1-p)AFFO 1 = (1-p)y E E 0, where p is the plowback
ratio, and : y E = equity income yield from firms underlying asset
equity [=AFFO/E, or @ property level EBTCF/(V-D)], E 0 = firms
underlying asset equity value at the beginning of Year 1. Then: DIV
2 = (1-p)y E E 1 = (1-p)y E [(1+g E )E 0 + py E E 0 ] = (1-p)y E
(1+g E +py E )E 0 = (1+g E +py E )DIV 1. g E = g py E g = g E + py
E, g E = g py E. Note: For a REIT, in the absence of growth
opportunities (all acquisitions @ NPV=0), E 0 is essentially based
only on the firms assets in place, and y E is the current equity
yield of those assets. Thus, g E is essentially the long-run growth
rate insame store earnings (EBTCF as levered). Reality Check: In
long run (in absence of NPV > 0 growth opportunities): High
Price/Earnings Ratio Either low r, or high same-store levered g E.
How sustainable is a low r?; How realistic is a high same-store
levered g E ?; Where does NPV > 0 come from? 35 2014 OnCourse
Learning. All Rights Reserved.
- Slide 36
- Recall Same store growth (existing property cash flow growth)
is pretty mundane: Easy to quantify, Easy to predict, Easy to
quantify, Easy to predict, Usually not very exciting (R.E. bricks
& mortar are cash cows, not growth stars, though use of
leverage can make more exciting). Usually not very exciting (R.E.
bricks & mortar are cash cows, not growth stars, though use of
leverage can make more exciting). Growth opportunities (NPV>0
actions) is the more interesting source of g : More uncertain &
difficult to predict (how realistic?, How sustainable?), More
uncertain & difficult to predict (how realistic?, How
sustainable?), More volatility in mkt expectns about magnitude of
NPV>0 opportunities. More volatility in mkt expectns about
magnitude of NPV>0 opportunities. Growth opportunities: Micro
(property) level: Buy Low or Sell High Deals; Arbitrage betw publ
& priv mkts; Entrepreneurial/Innovative Devlopment; Creative
Mgt of Operations. Macro (firm) level: Economies of Scale;
Franchise Value; Rental Mkt Dominance; etc. g is very important ( 1
pt g > 10% E ). Reflects: LR growth in EBTCF (sustainable same
store growth + plowback). LR growth in EBTCF (sustainable same
store growth + plowback). LR ability of REIT mgt to generate growth
opportunities (NPV>0 projects). LR ability of REIT mgt to
generate growth opportunities (NPV>0 projects). Plowback (NPV=0
acquisition of assets) is more uncertain: How long can firm find
new acquisitions at NPV=0? How long can firm find new acquisitions
at NPV=0? But analyst can short-cut around this question by using
AFFO version of GGM. But analyst can short-cut around this question
by using AFFO version of GGM. 36 2014 OnCourse Learning. All Rights
Reserved.
- Slide 37
- 37 Consider a basic challenge facing REITs REITs tend to be
value stocks, not growth stocks. But stock mkt is Land of Growth,
penalizes value stocks (like REITs). This may be good for REIT
investors (high returns), but it is tough for REIT managers (low
stock valuations, high cost of equity capital). Fundamental
challenge is REITs are real estate, and real estate is cash cows,
not growth plays. Real estate assets (including land) trade in
well-functioning markets (private prop mkt), making NPV > 0 hard
to find. How can REITs play in the growth show that is the stock
mkt arena?... Consider three ways REITs can grow share price
- Slide 38
- 2014 OnCourse Learning. All Rights Reserved.38 Three ways REITs
can grow price/share 1.Leverage 2.Plowback 3.Positive NPV
acquisitions
- Slide 39
- 2014 OnCourse Learning. All Rights Reserved.39 Leverage Recall
from fall course (Ch 13, basics of leverage) that leverage
typically skews the equity return components relatively away from
income and towards growth. Consider effect of leverage on static
portfolio of assets (pre-existing, same store assets) Suppose
assets produce $50/yr net cash flow, growing @ 2%/yr, and OCC (reqd
return unlevered) is 7%. Then portf of assets worth 50/(.07 .02) =
$1000. (Note: Inflation might be 3%/yr; property depreciates in
real terms 1%/yr)
- Slide 40
- 2014 OnCourse Learning. All Rights Reserved.40 Leverage Now
suppose REIT applies leverage of 50%... REIT has $500 equity, $500
debt (IO). Suppose debt interest rate = 5%/yr: $25/yr. As levered,
same-store REIT returns are (apply WACC inverted to solve for
equity): Total return: r E = r D + (r P r D )LR = 5%+(7%-5%)2 = 9%
Growth: g E = g D + (g P g D )LR = 0%+(2%-0%)2 = 4% Same-store cash
flow yield rate is: y E = 9% 4% = 5%. Leverage applied to
same-store assets gives REIT 4%/yr growth instead of 2% w/out levg.
REIT net cash flow (FAD or AFFO) is $50 $25 = $25/yr.
- Slide 41
- 2014 OnCourse Learning. All Rights Reserved.41 Plowback Now
consider effect of plowback (retained earnings). REIT net cash flow
(FAD or AFFO) is $50 $25 = $25/yr. Suppose REIT retains 20%, pays
$20 dividends: Dividend yield is 4% (not 5% cash yld rate of
assets). Reinvests $5, combined w $5 new debt (keep D/E ratio)
Asset holdings from last year to now: $1000 grew to $1020 (2%).
Allows $20 new debt (keep D/E). Reinvest new debt + plowback = $30,
assets now $1050. Debt is now $525, so equity is now $525.
- Slide 42
- 2014 OnCourse Learning. All Rights Reserved.42 Plowback REIT
equity has grown from $500 to $525: 5% growth rate. No new shares
have been issued, so: REIT yield = 4% (= $20 divs / $500 starting
equity). REIT growth = 5% ( = (525-500)/500. ) REIT total return =
4% + 5% = 9%. No free lunch, 9% is fair return, =OCC, given risk.
Changing plowback does not change share price (only growth rate),
as long as NPV=0 (Modigliani-Miller, GM book p.600-601). Effect of
plowback adds 1%/yr of growth (subtracts 1% from yield). (This on
top of effect of leverage: added 2% to growth without affecting
yield so added 2% to total return, due to increased risk (RP
+2%))
- Slide 43
- 2014 OnCourse Learning. All Rights Reserved.43 In this example
(typical): Leverage adds 2% to growth without affecting yield so
adds 2% to total return, due to increased risk ( r = rf + RP, RP
increased 2%). Plowback adds 1%/yr of growth (subtracts 1% from
yield), doesnt affect OCC or PV. REIT share price (& dividends)
now growing @ 5%/yr while its properties (& their cash flow)
are only growing @ 2%/yr same-store (less than 3% inflation). All
this with only NPV = 0. No new shares issued. No NPV 0
acquisitions. REIT Price/Earnings = Eq/AFFO = 500/25 = 20. (Approx
same as levered same-store assets Eq/EBTCF). Leverage &
Plowback
- Slide 44
- 44 Leverage & Plowback REIT can also grow in scale (mkt
capitalization) by issuing new shares or increasing D/E ratio. But
increasing debt will increase equity risk. Issuing new shares adds
to the float (number of shares outstanding), but does not in itself
change the price/share, assuming only NPV=0 investments. Neither
adding equity nor adding debt will by themselves change share price
in absence of NPV 0 investment. No change in P/E.
(Modigliani-Miller) (Possible exception: if scale itself adds
value?... Then NPV > 0.) Or other special effects: signaling? Or
COFD if they borrow too much?...
- Slide 45
- 2014 OnCourse Learning. All Rights Reserved.45 Third source of
share price growth: Positive NPV acquisitions, or entity-level
value addition Typical sources of growth opportunities (NPV > 0)
in REITs (if any): Developable land already owned. Entrepreneurial
abilities (in devlpt, or possibly other activities). Macro-level
abilities (scale economies?, franchise value?, econ of scope?...).
Differential property asset valuation in stock vs private property
markets. Any of these may be like call options (or real options).
Add value (PV) to the stock, w/out providing earnings (currently).
In our example, Price/Earnings > 20.
- Slide 46
- 2014 OnCourse Learning. All Rights Reserved.46 These three
sources of share price growth must (mathematically) account for the
difference in growth between REITs and direct private property
price appreciation (same-property) CAVEAT: These two graphs are a
little bit apples vs oranges, as the types of properties held by
REITs differ a bit from those held by pension fu nds in the NCREIF
index (but they are similar). REITs: 7%/yr Property: 4%/yr
- Slide 47
- 2014 OnCourse Learning. All Rights Reserved.47 REITs also have
generally provided cash yields at least as high as direct private
property (though again: this may partly be apples-vs-oranges in
terms of types of properties) REITs: 8%/yr Property: 6%/yr This can
occur in principle by the use of leverage that is positive in the
yield (cash pmt rate on the debt is lower than equity yield rate in
the underlying properties, e.g., int-only dbt with int rate <
cap rate capex/Val in properties: y D < y P ). Or maybe REITs
are more effective at property mgt, or purchase properties at
higher yields?...
- Slide 48
- Fundamental Growth Opportunities Are REITs growth stocks or
income stocks? Beneficial of Boston (BOB): An income REIT Owns
properties that pay $100 million / yr, in perpetuity, no debt. OCC
= r = 10%; g = 0. Using GGM, BOBs equity is worth: 48 2014 OnCourse
Learning. All Rights Reserved.
- Slide 49
- Sioux Realty (Sioux): A growth REIT Sioux owns stabilized
operating properties like BOBs that pay $50 million / yr in
perpetuity, no debt, plus: Land on which a completed project worth
$3000 million in one year can be built, at a cost of $2400 million
construction. Due to the risk in this development project (note the
operational leverage), the OCC for this project is 20%. Thus,
Siouxs value is: 49 2014 OnCourse Learning. All Rights
Reserved.
- Slide 50
- BOBs and Siouxs Price/Earnings multiples are: If they pay out
all their income as dividends, what are the current yields of these
two REITs? Answer: BOB yield = 10%, Sioux yield = 5%. Why is Sioux
a growth REIT? Is it because Sioux does development projects?
Suppose Sioux did not already own the land (and were similar to the
second best developer on the site)? 50 2014 OnCourse Learning. All
Rights Reserved.
- Slide 51
- Growth stocks have positive NPV opportunities. Value of Firm =
Value of Existing Assets in Place (less debt) Equity (E) + Net
Value of Growth Opportunities NPV >0 growth opps. result in high
REIT price to earnings multiples Collapsing it into the GGM
framework: g* is larger than g without growth opportunities. Value
of assets in place less debt 51 2014 OnCourse Learning. All Rights
Reserved.
- Slide 52
- Most REITs are not growth stocks most of the time, but some
REITs are growth stocks most of the time, and most REITs are growth
stocks some of the time. Last case is possible because of Typical
sources of growth (NPV > 0) opportunities in REITs (if any):
Developable land already owned. Entrepreneurial abilities (in
devlpt, or possibly other activities). Macro-level abilities (scale
economies?, franchise value?, econ of scope?). Differential
property asset valuation in stock vs private property markets. 52
2014 OnCourse Learning. All Rights Reserved.
- Slide 53
- What is REIT NAV ? Net Asset Value = REIT Assets Value (as
valued in property market *) REIT Liabilities** REIT Liabilities**
No. Shares Outstanding No. Shares Outstanding * As estimated by
REIT analyst, e.g.: mass appraisal: Divide REIT holdings into major
market segments (e.g., Offices in Boston, Warehouses in Chicago);
Divide REIT holdings into major market segments (e.g., Offices in
Boston, Warehouses in Chicago); Identify NOI (like EBITDA)
associated with each segment; Identify NOI (like EBITDA) associated
with each segment; Estimate current property mkt prevailing cap
rates in each segment; Estimate current property mkt prevailing cap
rates in each segment; Apply estimated cap rates to estimated NOI
to estimate asset value in each segment. Apply estimated cap rates
to estimated NOI to estimate asset value in each segment. Add and
adjust for: (i) Land holdings & construction in progress; (ii)
Non-asset- based earnings (e.g., prop.mgt fees) using estimated P/E
ratio. Add and adjust for: (i) Land holdings & construction in
progress; (ii) Non-asset- based earnings (e.g., prop.mgt fees)
using estimated P/E ratio. ** Theoretically should be market value
of debt (often book value used in practice). Comparison of
resulting NAV with the stock mkt based share price: Stock Mkt /
Property Mkt Valuation Differential, Stock Value NAV = NPV of REIT
Growth Opportunities (as valued by the stock mkt); &/or Errors
or omissions in the NAV estimation process. 23.2.3: Valuing REITs
as Collections of Assets: NAV-Based Valuation 53
- Slide 54
- 54 23.2.4 REIT Public/Private Arbitrage: PublicPrivate REIT
Share Price Premium to NAV Public versus Private Market Pricing of
Real Estate Equity REIT Share Price Premium to NAV 2014 OnCourse
Learning. All Rights Reserved.
- Slide 55
- The point is... REIT-based valuations & private property
mkt-based valuations appear to be different much of the time.
REIT-based valuations & private property mkt-based valuations
appear to be different much of the time. These differences do not
appear to be explainable by differences in the underlying operating
cash flows of the REITs vs the private properties; nor are they
explainable entirely by purely firm-level considerations (e.g.,
debt financing, entity-level mgt, trading, etc.). These differences
do not appear to be explainable by differences in the underlying
operating cash flows of the REITs vs the private properties; nor
are they explainable entirely by purely firm-level considerations
(e.g., debt financing, entity-level mgt, trading, etc.). Thus, at
least part of these differences appear to be micro-level valuation
differences, differences in the two markets perceptions of the
values of the same underlying properties as of the same point in
time (micro-level = bricks & mortar, underlying assets as
opposed to firm-level effects). Thus, at least part of these
differences appear to be micro-level valuation differences,
differences in the two markets perceptions of the values of the
same underlying properties as of the same point in time
(micro-level = bricks & mortar, underlying assets as opposed to
firm-level effects). There is some evidence that REIT valuations
tend to be a bit more volatile, and to lead the private property
market valuations in time (based on timing of major cyclical
turning points, the lead may be up to 3 years.) There is some
evidence that REIT valuations tend to be a bit more volatile, and
to lead the private property market valuations in time (based on
timing of major cyclical turning points, the lead may be up to 3
years.) 23.2.4 REIT Public/Private Arbitrage: 55 2014 OnCourse
Learning. All Rights Reserved.
- Slide 56
- Another perspective on this same point (from Chapter 12)
Exhibit 12-3: Equity REIUT Share Prices Versus Private Property Net
Asset Values (NAVs) 56 2014 OnCourse Learning. All Rights
Reserved.
- Slide 57
- 57 Two types of micro-level valuation differences: Longitudinal
& Cross-sectional Longitudinal (across time) difference: REIT
mkt in aggregate leads private market in aggregate (not perfectly,
but): Info flows from Public Private (mkt as whole) (Public mkt
more informationally efficient.) Cross-sectional (across REITs)
difference: Private Mkt NAVs contain information (again, not
perfect, but) Low P/NAV REITs tend to rise, & vice versa.
(Public mkt tends to tar all with same brush.) Info can flow from
Private Public (specific REITs, based on asset holdings)
- Slide 58
- 2014 OnCourse Learning. All Rights Reserved.58 Regarding the
longitudinal (aggregate) relationship: Traditional wisdom (and
historical evidence) suggests REITs lead Private (REIT Private).
But 2001-04 period indicated greater contemporaneous link, possibly
followed by a disconnect as private equity may have bubbled
(2004-07). Closer linkage betw the two mkts may be related to REITs
owning a larger share of properties in many mkt segments, such that
private investors in the direct property market are more influenced
by REIT capital. REIT fall in 2007 preceded that in the private
market by only a few months, but was swifter and sharper. Private
mkt derivatives pricing (NCREIF swaps, CMBX) was consistent with
(and nearly contemporaneous with) REIT share fall.
- Slide 59
- 2014 OnCourse Learning. All Rights Reserved.59 If Public
Private, then: Public > Private when values are rising; Private
> Public when values are falling.
- Slide 60
- 2014 OnCourse Learning. All Rights Reserved.60 Two types of
micro-level valuation differences: Longitudinal &
Cross-sectional Longitudinal (across time) difference: REIT mkt in
aggregate leads private market in aggregate (not perfectly, but):
Info flows from Public Private (mkt as whole) (Public mkt more
informationally efficient.) Cross-sectional (across REITs)
difference: Private Mkt NAVs contain information (again, not
perfect, but) Low P/NAV REITs tend to rise, & vice versa.
(Public mkt tends to tar all with same brush.) Info can flow from
Private Public (specific REITs, based on asset holdings)
- Slide 61
- 61 Third source of share price growth: Positive NPV
acquisitions (or entity-level value addition) Typical sources of
growth opportunities (NPV > 0) in REITs (if any): Developable
land already owned. Entrepreneurial abilities (in devlpt, or
possibly other activities). Macro-level abilities (scale
economies?, franchise value?, econ of scope?...). Differential
property asset valuation in stock vs private property markets.
These may be like call options (or real options). Add value (PV) to
the stock, w/out providing earnings (currently). In our example,
Price/Earnings > 20. 2014 OnCourse Learning. All Rights
Reserved.
- Slide 62
- When REIT valuation > Private valuation (positive REIT
premium to NAV): REITs have growth opportunities (NPV>0,
accretion) from buying in the private market. REITs have growth
opportunities (NPV>0, accretion) from buying in the private
market. REITs raise capital by issuing stock in the public mkt, use
proceeds to buy properties. REITs raise capital by issuing stock in
the public mkt, use proceeds to buy properties. When REIT valuation
< Private valuation (negative REIT premium to NAV): REITs are no
longer growth stocks, and their shares are re-priced accordingly in
the stock market (price/earnings multiples fall, REITs are priced
like value stocks, or income stocks). REITs are no longer growth
stocks, and their shares are re-priced accordingly in the stock
market (price/earnings multiples fall, REITs are priced like value
stocks, or income stocks). In the extreme, REITs may become
shrinking stocks, maximizing shareholder value by selling off
property equity (or debt) and paying out proceeds in dividends. In
the extreme, REITs may become shrinking stocks, maximizing
shareholder value by selling off property equity (or debt) and
paying out proceeds in dividends. The 2 mkts swing between these 2
conditions, also with periods when they are nearly equal valued.
Little arbitrage trading occurs when the 2 mkts are within 5%-10%
of each others valuations (due to transaction costs, firm-level
effects). Arbitrage trading tends to keep valuation differences to
less than 15%- 20%, but occasionally greater differences have
briefly occurred. 62 2014 OnCourse Learning. All Rights
Reserved.
- Slide 63
- How can a REIT remain a public REIT in business, and still
maximize shareholder value during times when the stock market
valuation of real estate is less than the private property market
valuation? IV REIT < MV PRIV Sell into the private market most
but not all of the equity in many of their properties (e.g., sell
properties into a partnership controlled by the REIT, with passive
equity partners), paying out proceeds in extraordinary dividends
(or stock purchases), while retaining effective operational control
over the assets (e.g., sell to passive partners, such as pension
funds): REIT retains scale & operational product. Sell into the
private market most but not all of the equity in many of their
properties (e.g., sell properties into a partnership controlled by
the REIT, with passive equity partners), paying out proceeds in
extraordinary dividends (or stock purchases), while retaining
effective operational control over the assets (e.g., sell to
passive partners, such as pension funds): REIT retains scale &
operational product. Issue secured debt (mortgages) collateralized
by the excess of MV PRIV over IV REIT, paying out proceeds as
extraordinary dividends. ( Risky.) Issue secured debt (mortgages)
collateralized by the excess of MV PRIV over IV REIT, paying out
proceeds as extraordinary dividends. ( Risky.) Sell some of their
properties outright into the private market (paying proceeds as
dividends or stock purchase), but subject to contracts to retain
the REIT as property manager (TRS). Sell some of their properties
outright into the private market (paying proceeds as dividends or
stock purchase), but subject to contracts to retain the REIT as
property manager (TRS). If private market valuations are
sufficiently high (and expected to remain so), consider going into
development projects with most financing coming from external
private equity and debt sources: Use the REITs entrepreneurial
capability; Use developable land already owned; Maximize leverage
of private market valuation. (Note: Though tempting, this strategy
is risky at the peak of a private market cycle.) If private market
valuations are sufficiently high (and expected to remain so),
consider going into development projects with most financing coming
from external private equity and debt sources: Use the REITs
entrepreneurial capability; Use developable land already owned;
Maximize leverage of private market valuation. (Note: Though
tempting, this strategy is risky at the peak of a private market
cycle.) Reinvest proceeds from domestic private market sales into
international real estate assets where valuations are lower (yields
are higher). Reinvest proceeds from domestic private market sales
into international real estate assets where valuations are lower
(yields are higher). 63 2014 OnCourse Learning. All Rights
Reserved.
- Slide 64
- 64 23.3 Some Considerations of REIT Management Strategy The
traditional real estate clich about the 3 determinants of value:
Location, location, location. The modern REIT clich about the 3
determinants of value: Management, management, management. Six
major strategies or strategic considerations 1) Financial strategy:
Caught between a rock and a hard place - REITs dont have
traditional C-corp income tax-based rationale for use of debt
financing. But REITs often need external capital (R.E. is
capital-intensive, and REITs must pay out 90% of earnings). Various
considerations enter the REIT capital structure equation: - REITs
dont have traditional C-corp income tax-based rationale for use of
debt financing. But REITs often need external capital (R.E. is
capital-intensive, and REITs must pay out 90% of earnings). Various
considerations enter the REIT capital structure equation: Stock
market wants growth; Real estate is not a growth asset without lots
of leverage (maximized by short-term or floating-rate debt); Stock
market doesnt like REITs to be highly levered (especially with
short- term or floating-rate debt). Solution: walk the tightrope
carefully.
- Slide 65
- 2014 OnCourse Learning. All Rights Reserved.65 23.3 Some REIT
Strategic Management Considerations (cont.) 2) Specialize (know
your market): Be a residential REIT or a retail REIT, etc Sometimes
some combinations are OK (e.g., office & industrial)
Geographical specialization is less cool (you gotta get scale
economies somehow!) 3) Build franchise value (brand name
recognition?): Improve tenant service with increased geographical
and product scope. 4) Consider vertical integration: Land, Devlpt,
Asset ownership, Property Mgt, Leasing, Tenant Svcs (logistics,
communications, etc), Information (databank); Allows REIT to ride
through periods when stock market undervalues real estate assets
relative to the property market (sell most asset ownership into
property market, retain control and ancillary functions, possibly
develop new buildings); During periods of low property market asset
valuation relative to the stock market, buy existing properties and
bank buildable land).
- Slide 66
- 2014 OnCourse Learning. All Rights Reserved.66 23.3 Some REIT
Strategic Management Considerations (cont.) 5) Take advantage of
Economies of Scale (such as they are): Are there scale economies in
REIT administrative costs? Are there scale economies in REIT
capital costs? Where are the limits of such economies? Are there
economies of scope in REIT service provision? 6) Try to develop
some market power (monopoly control) in local space markets: Buy
(or build) most of the space of a given type in a given local
submarket; But beware, rare is the submarket that has no potential
close substitute in the same metro area.
- Slide 67
- 2014 OnCourse Learning. All Rights Reserved.67 REIT
consolidation (to gain scale economies)
- Slide 68
- 23.4 Some REIT investor considerations 1) Choosing between
public (REIT) versus private (direct property) investment in real
estate Direct investment in private R.E. has problems regarding
illiquidity, need for active management and specialized local
expertise, and lumpy scale (capital constraints). But REITs provide
less diversification in a stock-dominated portfolio, and have more
volatile, less-predictable returns. Small investors without
specialized expertise should probably stick with REITs. Large
investors or those with specialized expertise can benefit from
direct private investment (albeit also with some REIT investment
for tactical or strategic portfolio management). 68 2014 OnCourse
Learning. All Rights Reserved.
- Slide 69
- 23.4 Some REIT investor considerations 2) REIT behavior in the
stock market On average REITs tend to be high-yield, low-beta
stocks ( 0.5, typically a small-to-mid cap value stock); REITs tend
to exhibit higher beta during market downswings than during
upswings ( 0.8 in down-markets, 0.3 in up-markets typical of value
stocks); REITs may be useful as a tactical tool for taking
advantage of asset market cycles in the private property market
(which is more predictable than the stock market). 69 2014 OnCourse
Learning. All Rights Reserved.
- Slide 70
- Exh.23-8: Correlation of Equity REIT Returns with Common Stock
Returns (60 month moving average) 70 2014 OnCourse Learning. All
Rights Reserved.
- Slide 71
- 71 Using WACC to avoid a common mistake... Suppose REIT A can
borrow @ 6%, and REIT B @ no less than 8%. Then doesnt REIT A have
a lower cost of capital than REIT B? Answer: Not necessarily.
Suppose (for example): REIT A:D/E = 3/7. D/V = L/V = 30%. REIT
B:D/E = 1. D/V = L/V = 50%. & suppose both A & B have cost
of equity = E[r E ] = 15%. Then: WACC(A)=(0.3)6% + (0.7)15% = 1.8%
+ 10.5% = 12.3% WACC(B)=(0.5)8% + (0.5)15% = 4% + 7.5% = 11.5% So
in this example REIT A has a higher cost of capital than B, even
though A can borrow at a lower rate. (Note, this same argument
applies whether or not either or both investors are REITs.) You
have to consider the cost of your equity as well as the cost of
your debt to determine your cost of capital. REIT Acquistion
Evaluation: Recall from Chapter 12 (sect.12.3.3) Corporate WACC
tells OCC of average corp asset. The "Weighted Average Cost of
Capital" (WACC) Formula... r P = (L/V)r D + [1-(L/V)]r E 2014
OnCourse Learning. All Rights Reserved.
- Slide 72
- 72 12.3.3: Risk is in the object not in the beholder. (Remember
from Ch.10: Match disc.rate to the risk of the investment whose CFs
are being discounted.) (Remember from Ch.10: Match disc.rate to the
risk of the investment whose CFs are being discounted.) Property
"X" has the same risk for Investor "A" as for Investor "B".
Therefore, oppty cost of cap (r) is same for A & B for purposes
of evaluating NPV of investment in X (same discount rate). Unless,
say, A has some unique ability to alter the risk of Xs future CFs.
(This is rare: be skeptical of such claims!) But Corp avg WACC is
not nec = acquisition OCC 2014 OnCourse Learning. All Rights
Reserved.
- Slide 73
- 73 Example... REIT A has expected total return to equity = 12%,
Avg.debt int.rate = 7%, Debt/Total Asset Value Ratio = 20% What is
REIT As (firm-level) Cost of Capital (WACC)? Ans: (0.2)7% +
(1-0.2)12% = 1.4% + 9.6% = 11%. REIT B has no debt, curr.div.yield
= 6%, pays out all its earnings in dividends (share price/earnings
multiple = 16.667), avg.div. growth rate = 4%/yr. What is REIT Bs
Cost of Capital? [Hint: Use Gordon Growth Model: r = y + g.] Ans:
6% + 4% = 10%. 2014 OnCourse Learning. All Rights Reserved.
- Slide 74
- 74 Example (cont.)... Property X is a Boston Office Bldg, in a
market where such bldgs sell at 8% cap rates (CF / V), with 0.5%
expected LR annual growth (in V & CF). It has initial CF =
$1,000,000/yr. How much can REIT A afford to pay for Prop.X,
without suffering loss in share value? Answer: $12,500,000 =
$1,000,000 / 0.08 = InitCF/ (OCC- g) = $1,000,000 / (8.5% - 0.5%).
Note: Prop.X value for REIT is not equal to: $1,000,000 / (11% -
0.5%) = $9,524,000. OCC relevant for valuing Prop.X purchase for
REIT is not 11% (REIT As firm level WACC). 2014 OnCourse Learning.
All Rights Reserved.
- Slide 75
- 75 Example (cont.)... Property X is a Boston Office Bldg, in a
market where such bldgs sell at 8% cap rates (CF / V), with 0.5%
expected LR annual growth (in V & CF). It has initial CF =
$1,000,000/yr. How much can REIT B afford to pay for Prop.X,
without suffering loss in share value? Answer (same): $12,500,000 =
$1,000,000 / 0.08 = InitCF/ (OCC- g) = $1,000,000 / (8.5% - 0.5%).
Note: Prop.X value for REIT is not equal to: $1,000,000 / (10% -
0.5%) = $10,526,000. OCC relevant for valuing Prop.X purchase for
REIT is not 10% (REIT Bs firm level WACC). 2014 OnCourse Learning.
All Rights Reserved.
- Slide 76
- Appendix 23: Agency Costs & Conflicts of Interest Some
major issues to watch out for 1) Transaction bias in UPREITs: Due
to tax-based conflict (different cost basis for LP investors vs
public stock investors)? 2) Real estate interests outside the REIT:
Do REIT managers have other real estate interests that compete with
the REITs properties or for the managers time & energy (other
properties not in the REIT, other interests such as brokerage or
management firms)? 3) Potential for self-dealing: Do REIT managers
have incentives to have the REIT engage in Sweatheart deals with
brokerage, management, development firms in which they have
interests? 4) Take-over difficulties re 5-or-Fewer Rule: REIT
governance often makes hostile takeovers particularly difficult, in
part due to 5-or-Fewer Rule. 76 2014 OnCourse Learning. All Rights
Reserved.
- Slide 77
- Public Investors (Stockholders) Private Investors (Partnership
Unit-holders) REIT Umbrella Partnership (Operating Partnership: OP)
Property Partnership Property Partnership Property Partnership
Property TheUPREITStructure 77 2014 OnCourse Learning. All Rights
Reserved.