Question

Discuss some of the basic issues and their significance in evaluating REITs and their financial statements.

Answer 1

Basic Issues-

1. Underlying property-

• Valuation of underlying property needs to be done in proper manner.
• Valuation would depend on various factors-
  • Location of property
  • Discounting rate
  • Dividend yield
  • WACC
  • Capitilization rate
• Sector under which REIT is majorily composed of-
  • If majority of properties covered under REIT are housing (residential) then accordingly valuation is ascertained and value is realised. Residential property have different risk which needs to be ascertained
  • If properties are office parks - then occupancy and rental income from office parks needs to be evaluated. For eg if majority of office park are Tech parks then growth in Tech parks needs to be evaluated
  • If properties are Hotels then occupancy of hotel rooms needs to be considered (Total room keys), occupancy ratio
• Risks -
  • Slower than expected growth
  • Meaningful drop in occupancy levels and slower than expected growth in rental incomes may pose a risk for growing annuities
  • Regulatory changes that may increase the tax incidence or hinder further property development pose and additional risk for commercial real estate portfolio.
  • In ability to renew lease contracts at prevailing or improved rental rates
  • Restricted cash flows may hamper incremental growth or acquire assets under Right of First offer deed.
  • Notices for not following deed- by use of premises other than permitted use or not taking approval
  • Unable to trace environmental problems and approvals.
  • Qualification for exemption in Income tax needs to be checked
  • Audit qualifications on underlying properties and tenants