Question
In: Finance
Which are the five ways in which a REIT can grow income and increase funds from...
Which are the five ways in which a REIT can grow income and increase funds from operations, thus securing its dividend and making dividend
increases possible
Solutions
Expert Solution
Funds from Operations (FFO) Funds from operations (FFO) is a benchmarked industry term defined by the National Association of Real Estate Investment Trusts. or NAREIT. It’s defined as GAAP net income + depreciation and amortization – gains from property sales.
Adjusted Funds from Operations (AFFO) Adjusted funds from operations (AFFO) is a slightly complex because, unlike FFO, there is no objective formula that all REITs use. However, in general AFFO is calculated by reducing FFO (operating cash flow) by maintenance costs (capex) and taking into account something called straight line lease revenue.
AFFO Payout Ratio Smart investors are used to checking a corporation’s dividend sustainability by looking at either the EPS or FCF payout ratio. However, this is a mistake for REITs because, as previously explained, a REIT’s reported EPS will be substantially lowered by its non-cash depreciation and amortization expenses.
Debt/EBITDA (Leverage Ratio) Never forget that all REITs need access to cheap debt to grow. That’s because generally the cost of equity is higher than the cost of debt, which means that debt is a cheaper way to leverage equity capital and lower the overall cost of capital.
Credit Rating One more good source for making sure a REIT isn’t overextending itself with debt (and a proxy for the company’s overall quality) is to look at its credit rating. An investment-grade credit rating is BBB- and above (Standard & Poor's rating scale), and the higher a REIT’s rating the easier time it has borrowing cheaply.
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