1. 1 Real Estate Investment Trusts © Northern NV Chapter

2. 2 REITs and this Class Any stock mentioned is used as an example and is not intended as a recommendation to buy or sell. Further research should precede any investment decision by you or your Investment club. © Northern NV Chapter

3. 3 What are REITs ? REITs are Real Estate related investments which share the benefit of a stocks liquidity. When you buy a stock you are buying a business. The same applies when you buy a REIT.

4. 4 What are REITs ? They must have 75% of assets invested in real estate, mortgage loans, other REITs or Govt. securities. REITs are not taxed at the corporate level. To maintain REIT status they must pay out 90% of net income as dividends to owners, and derive 75% of their income from real estate related business.

5. 5 Types of REITs Mortgage REITs make and hold loans and other obligations that are secured by real estate collateral. Equity REITs are companies that buy, sell, manage, renovate, develop real estate. Hybrid REITs own both properties & mortgages For this class we will deal exclusively with Equity REITs

6. 6 REITs & the Market From Oct. 1981 to Oct 2001 REITS have given owners a 12.6 % annual total return. They have a low correlation with the rest of the Market and will not rise as fast as the Market when it becomes bullish, nor fall as much during bearish times.

7. 7 REITs & the Market REITS are seen as being less risky because they have hard assets to back them up. (Real Estate) Owners are less likely to sell on a rumor and hold onto their shares during bear markets because a significant yield will soften the blow of declining prices.

8. 8 REITs vs. the Markets

9. 9 Dollar Cost Averaging (DCA) Re-invest all of your earnings!!! It has been proven when you increase your position in stocks you own by regularly reinvesting during up and down markets you will lower the overall cost of the stock you own. First buy is 100 shares at 10.00 per share ($1000) Second buy 125 shares at $8.00 per share ($1000) Third buy is 200 shares at $5.00 per share ($1000) Fourth buy is 100 shares at $10.00 per sh ($1000) $4000525 sh.$7.62

10. 10 REITs role in DCA Of the almost 11% returns by the market since 1922 approximately 40% has come from dividends. This is due to the “Magic of Compounding”. This is a result of earning on your earnings, not just the principal.

11. 11 REITs role in DCA If your stock dividend from 100 shares was 15.20 and your share price was $7.62 you would receive two additional shares upon re- investment. At the next dividend pay date you would be receiving dividends from 102 shares. This dividend payment would be $15.50 (102 times dividend per share of.152 = $15.50)

12. 12 Importance of Dividends

13. 13 REITs role in DCA REITs can invest for you while you may be involved with other projects. Larger dividend payments allow you to use new money to further diversify or add to that investment. Some investors feel less stressed when they see regular payments (dividends) reinvested especially when they don’t write a check for this to be accomplished.

14. 14 REITs & Total Return REITs retain little capital for growth, thus lessening the chance of rapid price appreciation. Be sure of where REITs fit into your portfolio and how you want to weight them.

15. 15 REITs & Total Return Only REITs that have easy and cheap access to capital can grow their business and make an acceptable long term growth prospect. Realize that the yield will make up a substantial portion of the stocks Total Return.

16. 16 Why REITs vs. other High Yield Investments? Utilities are a highly regulated industry and must answer to Federal, State, and local governments. REITs are less affected by weather, although retail can be an exception. Corporate Bonds can be competitive. Make sure you are dealing with a financially stable business.

17. 17 Why REITs vs. other High Yield Investments? High Yield can also be translated to mean High Risk. The highest yielding investment doesn’t mean the best investment. Remember the Reward/Risk factor.

18. 18 So why REITs ? As mentioned earlier, you can divest quickly if a situation came up where you had to have money. They provide significant dividend income with slow to moderate growth. You own Real Estate businesses without... then

19. 19 What kind of REIT is right ? Diversification is a key! Diversify by: Sector Region Size Retail Residential Industrial Hospitals Hotels North South East West Small Medium Large

20. 20 Real Estate Cycles The Depression…High vacancies, low rents and real estate prices are depressed. Foreclosures and repo’s are on the rise. Gradual Recovery…Occupancy rises, rents stabilize gradually increasing. Property prices regain normalcy. Still no new or very little construction. The Boom…high occupancy, rising rents equal better returns. Construction makes sense. The overbuilding and downturn…Building outpaces demand eventually and leads back to depressive state. Here the cycle is complete and starts anew!

21. 21 REIT Cycles Commercial REITs are tied not only to the national economy but to the local economies. Being to heavy in an industrialized area could have other trickle down effects. With layoffs, industrial parks may reduce occupancy, retail stores may close or relocate. This may have an effect on apartment vacancies or other areas where people live or spend their money.

22. 22 But on the other hand... Relocation can mean there may be a boom beginning in another region or industry. This is where the three areas of diversifying will lessen any difficulties in your portfolio. The strongest and most able companies will weather the downturns and reward shareowners in the long run.

23. 23 How to spot the right REIT As with any investment, good management will be essential to continuing satisfactory returns. Many of the same qualities regular companies management’s have shown is what you will be looking for in a REIT. Have they grown the company? Remained profitable? What is their stake in the company?

24. 24 Analyzing Management Like other companies, the ability of mgt. to grow the business, (sales and earnings), will be the single most important aspect of analysis. The earnings per share growth, while important, will be compared to FFO or Funds from Operations The main difference between FFO and EPS is that the FFO calculation will give net income before the depreciation and amortization expense is deducted

25. 25 Analyzing Management w/ Funds from Operations Two arguments exist for using FFO vs. EPS. The first is that real property does not usually depreciate in value, so to include a depreciation cost on a property that is appreciating doesn’t give the accurate picture. The second is that not all properties appreciate. Owners need to account for costs associated with structural improvements to maintain the property value. Adding back depreciation can therefore provide an overly positive outlook for the property.

26. 26 Analyzing Management Online Premium Services, OPS, uses EPS for the calculation while Value Line gives the FFO figures. You can plot this manually on the SSG Sec. 1 Chart.

27. 27 Analyzing Management Note that a Pre-Tax Profit number is given. REITs do pay taxes on non property related earnings.

28. 28 Analyzing Management Look for managers who are aware of market conditions and are capable, and willing, to add properties when the right opportunity exists. Be wary of managers who look to make deals regardless of whether the real estate market is overpriced. Looking to add rents, “income”, at any cost may hinder future success.

29. 29 Analyzing Management REIT’s with the best access to capital will perform the best over the long term as they will have financing pre-approved at usually the lowest rates. Higher interest expense will reduce future EPS. Check the financial ratings. (S&P and VL). Lowest rating before Junk status is BBB- Have VL Financial Strength at least B

30. 30 Debt Management A company that maintains a comfortable level of debt along with a strong balance sheet will be more favorable for investment opportunity. With debt there is also two ways to look at what is considered a “comfortable” level. Debt/Market Cap Ratio = Total Debt/ (Common + Preferred Equity + Total Debt Debt/Asset Value Ratio = Total Debt/Total Asset Value The Debt/Assets Value is more conservative and usually closer to what the company is actually worth.

31. 31 Debt Management What determines a strong balance sheet are modest amounts of debt relative to it’s market value or asset value. Strong coverage of interest payments on that debt. This means they must have sufficient cash flows.

32. 32 Debt Management The REIT must have a manageable debt maturity schedule. Know the reasons they are taking on debt... To grow or improve the properties…good To pay dividends or other obligations…not good.

33. 33 Debt Guidelines According to NAREIT the average debt/market ratio was approx. 46%. (2001) Anything over 50% debt ratio is worrisome to many REIT investors. Especially where a sector might not be cushioned by long term leases. (Hotels).

34. 34 Debt Guidelines A ratio under 40% is considered conservative and would indicate a well run and capitalized company. Competition or overbuilding can make these levels seem riskier.

35. 35 Debt Guidelines While NAIC recommends investors look for companies with debt levels below 33-35%, remember that REIT’s,by law, pay out 90% of earnings to shareowners. This is a reason they may take on more debt than a standard public company, and equally important, why they must have easy and cheap access to capital when the need arises.

36. 36 Interest Coverage Many REIT investors will also look at the Interest Coverage Ratio. This ratio will tell the investor how much of the interest from debt is covered by Net Operating Income, or NOI. An example would be High Stakes Property REIT has NOI of $24 million. Their debt is $120 million, of which the interest expense is $12 million. The Interest Coverage Ratio would be NOI  Int. Expense = 2.0 An Interest Coverage Ratio below 2.5 is cautionary.

37. 37 Final word on debt Look for variable rate debt to be no more than 10-15% of the REIT’s assets. Rising rates could bring about negative earnings surprises! Effective management will refinance debt well before maturity and seek as long maturity as possible. According to Green Street Advisors the amount of short term debt, (less than two years), is approximately 5.8%.

38. 38 Insider Ownership Management that own significant pcts. (%) of the business they run will, in theory, make the best decisions for the long term success of that business. Green Street Advisors “2001 REIT Pricing” report stated that the average insider ownership was 13.6%. Many REIT’s started out as private, this partially accounts for the higher numbers. Remember, as a company issues more shares the percent will decrease.

39. 39 Payout Ratios A low payout ratio allows a REIT to retain more cash for external growth. To high of a payout ratio could signal a possible dividend reduction which would reduce the price and therefore reduce the possibility of better access to capital. For income only REIT’s you’ll want the higher payout ratio, for REIT’s with growth potential look for lower payout ratios.

40. 40 Payout Ratios KIMCo Corp. Note: Col. F vs.. Col.C The payout ratio is calculated in the SSG by dividing the dividend per share by the earnings per share, (EPS). Remember dividends are paid from net income

41. 41 Capitalization Rates REIT companies will refer to the income that a property will produce within a certain period of time as the “Cap Rate”. Most often applied to cash flow not net income. An example would be that if a company was generating $10,000 per year on a property that cost $100,00 the cap rate would be 10%. or Net income divided by the purchase price = Cap Rate

42. 42 Capitalization Rates If purchasers were basing their willingness to buy properties on Cap Rates then you would need an increase in income, (i.e., rents or leases), to provide an acceptable return on the purchase price. For example, if in ten years you had now increased the income to $20,000 per year and sold it at the same 10%Cap rate, you would receive $200,000 for the sale, minus selling costs. REIT analysts use this number to make judgments on future FFO estimates.

43. 43 Your Portfolio and REIT’s NAIC recommends to invest in Growth Companies. With this in mind, this is where you or the Club you belong to should decide whether to diversify into these type of stocks. Based on the plus and minuses of REIT’s, would you or your club feel a desire to have these holdings? What were some of the plusses and minuses discussed? Any more?

44. 44 Your Portfolio and REIT’s Remember if you decide to do this, follow the NAIC Principles!!! Reinvest all earnings to take advantage of compounding! Invest for the Long Term! Invest in Quality Companies. ( I left out growth on purpose)!!! Diversify, Diversify, Diversify!!!

45. 45 Where to look ? Value Line has a section for REIT’s. Go to better-investing.org and type in an author or a word to search for topics. Enter the Ticker symbol for OPS, click GO If you only know the name, click here and type the name.

46. 46 Resources & Acknowledgments INVESTING IN REITS By: Ralph L. Block BETTER INVESTING AUTHORS Amy Rauch Neilson Brian Lewis Herb Barnett Ray Smith (WSJ) WWW.NAREIT.COM www.dividenddiscountmodel.com www.reitnet.com

47. 47 Final Thoughts Be sure to check the chapter web page for the most updated information on Chapter Classes or events www.better-investing.org/chapter/nnevada