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Strategies & Market Trends : Value Investing

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William Cloutier

To: Graham Osborn who wrote (58820)	1/1/2017 7:38:55 PM
From: E_K_S	3 Recommendations Read Replies (1) of 78705

A few comments on REITs. I contribute at the REIT forum @ InvestorVillage. Here is the link to Grumpy's REIT spreadsheet. This is a cloud based spreadsheet that breaks out many REITs performance/financials by sector. It's probably the best compiled (hard linked data) information for REITs. The value metrics I use are gleaned from individual company web sites and/or 10K's and quarter/annual management presentations. Grumpy's list is good for looking at specific sector performance. For my REIT investments, I look at the FFO (Funds From Operations) and/or the AFFO (Adjusted Funds From Operations) when evaluating the returns for investment real estate. FFO is the cash flow generated before depreciation and fix up w/ the largest expense made up by interest/debt service. AFFO typically used for Hotel REITs reflects the cash flows after the direct room/building fix up expenses. Both cash flow estimates reflect a high occupancy rate usually greater than 95% but in all cases a close to fully rented building/facility. It's the best case measure of generated cash flow which is used as the basis for the dividend payment. You want FFO and AFFO to more than cover the dividend (1.2x is good and more is even better) and you want these cash flows to grow (I like the growth rate in FFO >= to the dividend yield). Investors also look at Capitalization rates: The capitalization rate is the rate of return on a real estate investment property based on the income that the property is expected to generate. The capitalization rate is used to estimate the investor's potential return on his or her investment. ...Capitalization Rate = Net Operating Income / Current Market Value. I find that the value proposition in REITs are the small cap operators that can add value to their under priced property acquisitions. I invest in the small cap operators that locate under-priced properties, fix them up (convert buildings for specific use; ie. medical reits) which is made up of several value added components. First is to locate an undervalued assets (typically valued by cap rate). Second add value by remodeling and/or converting the property into a special use that will demand a higher rent. Third, find a long term tenant (10 years or more) that will contract to pay a growing revenue stream over that term (usually w/ modest price increases). The REIT will then obtain the financing (through equity and/or bonds). Some of these small cap high growth REITs will 'flip' their properties, buying at an undervalued cap rate (underutilized, partially leased), do their high value added conversions and then sell their property at a lower cap rate. The difference in cap rate (buy at high cap rate like 10%) and sell at lower cap rate (like 6.5%) the difference 3.5% is their gain. This is accomplished w/ mostly borrowed money so the ROI can be huge on a project 35%-40% if completed on time and under budget. The only way the mid-cap and large cap REITs can grow is through rent increases and/or acquisitions of underutilized (low vacancy) properties. That is why I like the smaller operators as their projects when completed can move the needle on Revenues and FFO/AFFO. You just need to be careful of potential conflicts by management and their partners/brokers since their interests are sometimes in conflict w/ the shareholder's interests. Two small cap REITs I have recently bought (and continue to accumulate shares) are Bluerock Residential Growth REIT, Inc. (AMEX: BRG) and City Office REIT, Inc. (NYSE: CIO). You also need to be in the right part of the interest rate cycle but the major key long term is/are the sustainability of growing lease/rental rates. It's still a tough business and difficult to find undervalued operators (they are undervalued for a good reason too). I recently bought SOHO and have done quite well. The stock is up over 50% in the last 60 days primarily from the company's unexpected $10mln stock buy back announcement. They continue to make money from the destination Hotel flips and are now expanding into Florida There are only 11 properties in their portfolio so every new project can really move the profitability needle. I sold 25% of my position Friday and will probably close out the remaining shares early 2017 once I am able to book long term capital gains. EKS

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