REITs and listed real estate companies

What you will learn

• What a REIT is and how the German REIT differs from an ordinary property company
• How to calculate net asset value (NAV), the discount or premium to NAV, and loan-to-value (LTV)
• Why analysts use FFO and AFFO, and how to check dividend cover
• How falling values and higher rates affect the share

Explanation

Real estate as a stock-market sector is introduced in the course Sector Analysis.

Two types of listed real estate

A listed real estate company is a normal stock corporation whose business is owning, letting or developing property. It pays corporate income tax and trade tax and decides freely on its dividend.

A REIT (Real Estate Investment Trust) is a property company with a special legal status. If it meets strict conditions, it pays little or no company-level tax; income is taxed at the shareholder.

The German REIT (G-REIT, under the REIT Act, REITG, since 2007) must, among other things:

• be a listed stock corporation with its registered office and management in Germany;
• hold at least 75% of its assets in real estate and earn at least 75% of its gross income from real estate (letting, leasing, sales);
• distribute at least 90% of its profit under German commercial law (HGB) as dividends;
• keep a free float of at least 15% (25% at listing); no investor may directly hold 10% or more of the shares;
• not hold German rental housing built before 2007.

In return it is exempt from corporate income tax and trade tax (check the current REITG).

Key figures

Net asset value (NAV) is the value of the properties (as estimated by external valuers) plus other assets, minus debt and other liabilities. Divided by the number of shares it gives NAV per share.

Discount to NAV = 1 − share price ÷ NAV per share

A discount may signal doubts about valuations, expected rate rises or distrust of management. It is not automatically a bargain: appraisals are not sale prices and often lag the market.

Loan-to-value (LTV) = debt ÷ property value. Higher LTV means NAV reacts more strongly to value changes.

Funds from operations (FFO) adjusts net profit for items that say little about recurring rental income: FFO = net profit + depreciation − gains on property sales (plus further adjustments, such as revaluation results). Adjusted FFO (AFFO) also deducts maintenance capital expenditure, the money needed to keep buildings lettable. AFFO is closer to the cash the company can really distribute. Definitions differ between companies; read the annual report.

P/FFO (price ÷ FFO per share) replaces the price-earnings ratio. The AFFO payout ratio (dividend ÷ AFFO per share) shows whether recurring cash covers the dividend.

Interest-rate sensitivity

When interest rates rise, valuers apply higher yields, so NAV falls, and maturing loans are refinanced at higher rates, so FFO falls. Share prices often react before appraised values change.

Worked example

Hypothetical example: "Alpha Property AG" owns properties valued at €2,000 million and has €800 million of debt. Other items net to zero. It has 100 million shares, trading at €9.00. Last year's net profit was €60 million, depreciation €50 million, gains on property sales €10 million, maintenance capital expenditure €20 million. The dividend is €0.72 per share. Taxes and costs are excluded.

1. NAV = €2,000m − €800m = €1,200m; NAV per share = €1,200m ÷ 100m = €12.00.
2. Discount to NAV = 1 − €9.00 ÷ €12.00 = 25%.
3. LTV = €800m ÷ €2,000m = 40%.
4. FFO = €60m + €50m − €10m = €100m, or €1.00 per share; P/FFO = €9.00 ÷ €1.00 = 9.0.
5. AFFO = €100m − €20m = €80m, or €0.80 per share; AFFO payout = €0.72 ÷ €0.80 = 90%; dividend yield = €0.72 ÷ €9.00 = 8.0%.
6. Stress test: property values fall 10% to €1,800m. NAV = €1,800m − €800m = €1,000m, a fall of 16.7%; LTV rises to €800m ÷ €1,800m = 44.4%.
7. Refinancing: €200m of debt is refinanced from 2.0% to 4.5%. Extra interest = €200m × 2.5% = €5m, so FFO falls to €95m (−5%).

Leverage turns a 10% fall in values into a 16.7% fall in NAV.

Common mistake

Practice activity

Hypothetical company "Beta Logistik REIT": properties €3,000m, debt €1,350m, 150 million shares, share price €8.40. Net profit €90m, depreciation €75m, gains on sales €15m, maintenance capital expenditure €30m, dividend €0.80 per share. Calculate NAV per share, discount to NAV, LTV, FFO per share, P/FFO, AFFO per share and the AFFO payout ratio. What concerns you?

Key takeaways

• A REIT avoids most company-level tax in exchange for strict asset, income and distribution rules.
• NAV and LTV describe the balance sheet; FFO, AFFO and the payout ratio describe recurring income.
• Leverage magnifies changes in property values: a 10% fall in values can cut NAV by much more.
• Listed property shares react quickly to interest-rate expectations.

Next step

Next, you will look at the opposite approach: open-ended real estate funds in Germany, which are not listed and come with special liquidity rules.