Publically Traded Real Estate Securities

Types of Publically Traded Real Estate Securities

• REIT
• MBS
• REOCs
• Stock`

Real Estate investment Trusts (REITS) are tax-advantaged entities that typically own, operate, and-to a limited extent-develop income-producing real estate property. They include equity REITs and mortgage REITs.

Real estate operating companies (REOCs) are taxable real estate ownership companies. They enagege to a large extent in the development of real estate, often with the intent to sell. The primary CF income from sales.

Mortgage-backed securities are asset-backed securitized debt obligations. They include commercial MBS and residential MBS.

REITs

REITs are required to:

• Distribute 90%+ earnings
• Invest at least 75%
• Derive at least 75% income from rental income or interest on mortgages

Most REITs in US are self-managed, otherwise management fee need to be paid to third-party managers.

Benefit of REITs investment:

• Liquidity
• Transparency
• Diversification
• High-quality portfolio
• active manabgement
• stable income
• tax efficiency

Disadvantage:

• Lack of retained earning
• Regulation
• Reduced portfolio diversification benefits
• Limited in types of assets owned

Valuation

Net Asset Value

Market Value (MV) of equity: $\text{MV of asset}-\text{MV-liabilities}$, dividing by number of shares outstanding will get NAVPS (Net Value of Market Per Share). Compare with REITs will get the market situation.

Steps:

1. Values of property held by REITs and REOCs are estimated by capitalizing the NOI using capital rate: $P=\frac{NO{I}_1}{\text{r-g}}$, where the cap rate = $r-g$ can be referenced from similar properties in the market.

NOTE

NOI need to be annualized and time growth rate to get $NO{I}_1$

2. The book value of cash, AR, prepaid expense, land for future dev are added to obtain estimated gross asset value. Good will and DTA will be excluded
3. Debt and other liabilities are subtracted. DTL will be excluded.
4. Divide shares outstanding to get NAVPS

Considerations:

• Cap rate not accurate
• NAV reflects value to a private market buyer
• NAV implicitly treats REIT as a static pool of assets
• NAV estimates can become quite subjective when property market become illiquid and when REITs own many property.

Relative Value (Price Multiple)

P/FFO or P/AFFO are used in relative valuation

FFO

Funds From Operation(FFO) is generally calculated as NI + Losses from sales of properties - Gain from sales + Depreciation and amortization.

AFFO

Based on FFO:

• Minus Non-cash rent adjustment from accounting
• Minus recurring maintenance capital expenditure and leasing commissions.

NOTE

AFFO is also known for funds available for distribution (FAD) or cash available for distribution (CAD).

Comparision of Private and Public Real Estate Investment

Advantage

Private Real Estate	Public Real Estate
Direct exposure to real estate fundamentals	Tracks real estate fundamentals over the long term
Stable returns / low volatility	Liquidity
Income and capital appreciation	Access to professional management
Property performance drives returns	Potential inflation hedge
Low correlations with other asset classes	Potential for strong alignment of interests
Potential inflation hedge	Tax-efficient structure avoids double taxation (REITs only)
Control	Potential for exposure to diversified portfolios

Private Real Estate	Public Real Estate
Potential to earn illiquidity premium	No special investor qualifications beyond equity investing generally
Wide variety of strategies / few restrictions	Greater regulation and investor protections
Tax benefits (e.g., accelerated depreciation, deferred taxes in some markets when sales are reinvested in other real estate)	Access to diverse sectors, including data centers, medical offices, and self-storage
	Low investment requirements
	Low entry/exit costs
	Limited liability
	High transparency

Disadvantage

Private Real Estate	Public Real Estate
Low liquidity	High volatility (compared with private real estate)
Difficult-to-exit	Equity market correlation is high in short term
High fees and expenses	REIT structure limits possible activities
Appraisal valuations commonly lag changes in market conditions	Stock prices may not reflect underlying property values (i.e., trade at discount to NAV)

Private Real Estate	Public Real Estate
Fewer regulations to protect investors	Dividends taxed at high current income tax rates
Some managers focus on asset gathering over high profitability	Equity market correlation is high in short term
High investment minimums and high net-worth requirements	Regulatory compliance costs are prohibitive for small companies
Low transparency	Poor governance/mis-aligned interests can penalize stock performance
High returns often derived from leverage	Equity markets often penalize companies with high leverage