Question: What is the investing formula used for Reits (Real Estate Investment Trusts) to find the value before buying the stock? – Formulas and Values
The most common formula used to evaluate Real Estate Investment Trusts (REITs) before buying their stock is the Funds From Operations (FFO) and Adjusted Funds From Operations (AFFO) formulas. FFO and AFFO are metrics specific to REITs and are used to gauge the company’s operating performance and financial health. Here’s a breakdown:
- Funds From Operations (FFO): FFO is a measure of cash generated by a REIT’s operations. It’s calculated by adding depreciation and amortization to earnings and subtracting any gains from sales of property. The formula is:FFO = Net Income + Depreciation + Amortization – Gains on Sales of PropertyFFO is considered a better metric than net income for REITs because it adds back non-cash expenses like depreciation and amortization, which are significant in the real estate industry.
- Adjusted Funds From Operations (AFFO): AFFO further adjusts FFO to reflect the cash available for distribution to shareholders after accounting for recurring capital expenditures necessary to maintain the REIT’s properties. The formula is:AFFO = FFO – Recurring Capital ExpendituresRecurring capital expenditures include expenses like property maintenance and repairs. Deducting these expenses from FFO gives a clearer picture of the cash flow available to distribute to shareholders.
Once you have calculated FFO and AFFO, you can use these metrics to assess the valuation of the REIT. Typically, investors compare the REIT’s FFO and AFFO to its market capitalization (market value of its outstanding shares) to determine its price-to-FFO or price-to-AFFO ratios. These ratios help investors assess whether the REIT’s stock is undervalued, overvalued, or fairly priced compared to its earnings.
Remember, while FFO and AFFO are essential metrics for evaluating REITs, it’s crucial to consider other factors such as the REIT’s property portfolio, occupancy rates, debt levels, management quality, and market conditions before making an investment decision.
Below is a simple REIT investment calculator, which calculates the Price-to-FFO ratio based on user input for market capitalization and FFO. Users can input the market capitalization and FFO values, and the calculator will compute the Price-to-FFO ratio automatically.
Note: For real estate investment trusts (REITs), standard metrics like earnings per share (EPS) or price-to-earnings (P/E) ratios may not deliver the most accurate picture you need of performance and value. Instead, professionals often turn to funds from operations (FFO) and adjusted funds from operations (AFFO) as key indicators. Understanding FFO and AFFO is thus crucial for accurately evaluating a REIT’s financial health, growth prospects, and overall investment potential.
FFO and AFFO are tailored to the needs of REITs. Unlike traditional companies, they generate income primarily through property rentals and must distribute most of their earnings as dividends. FFO puts depreciation and other noncash charges back into the net income, giving a clearer view of the REIT’s operating performance. AFFO takes this a step further by accounting for capital expenditures and other adjustments, providing a picture of the REIT’s sustainable dividend-paying capacity.
1. FFO Analyizer = Price-to-FFO ratio (Funds From Operations)
REIT Investment Calculator
What is a good FFO Ratio?
1. Modest Risk
A company with modest risk has a ratio of 0.45 to 0.6 (%)
2. Intermediate Risk
one with intermediate-risk has a ratio of 0.3 to 0.45 (%)
3. Significant Risk
one with significant risk has a ratio of 0.20 to 0.30 (%)
4. Aggressive Risk
one with aggressive risk has a ratio of 0.12 to 0.2 (%)
5. High Risk
and one with high risk has an FFO to total debt ratio below 0.12 (%)
2. AFFO Analyizer = Price-to-AFFO ratio (Adjusted Funds From Operations)