HOW to ANALYZE a REIT - REIT Investing for Beginners Using RioCan (REI.TO stock) - YouTube

Today we're talking about REITs, how to analyze REITs and the differences between REITs and other stocks coming up.

Welcome back to the channel, guys. If you're new here my name is Sean.

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So today we're talking about REITs which is an acronym that stands for Real Estate Investment Trust.

They're basically companies that operate real estate as their business.

This could be commercial, industrial, residential real estate, etc.

The big thing here is that REITs can be publicly traded which means that you can hold stock

or indirectly own this real estate without actually owning the physical property.

The other really big thing about REITs that makes them different than other companies is

they can give out up to 90% or more of their operating income in the form of dividends.

This is very similar to owning a piece of real estate yourself. That would be like the rental income.

So it's important to note there are two types of REITs. One is called an Equity REIT

the other is a Mortgage REITor an "m-REIT."

An Equity REIT is what I just said which is a company that owns and operates real estate as their business model.

An m-REIT is actually a little different because it's a company that actually loans

out the money or executes the mortgages and makes it's money off of the interest of those loans.

Now let's quickly cover the pros and cons of REITs vs a regular real estate investment

and what I mean by that is like a physical house or condo that you may rent out.

So one really obvious advantage would be the ease of purchase and sales

You don't really have to do much to be able to own any piece of real estate.

It's got a very low cost of entry. You don't need to have tens of thousands of dollars for a downpayment

like you would for a physical piece of property. Instead if you have 100 or 1,000 dollars

you can easily get a few shares of a REIT and still be in the real estate game.

Another thing here is you can purchase commercial real estate which is typically a little bit tougher to get into because it's usually a lot more expensive.

But if you have a REIT with commercial real estate built in you can be part of that as well.

Another really good thing if you're a dividend investor is that REITs are required to pay most of their net income out in the form of dividends

so when they're collecting their rent and making all the money off their operations

these are supposed to come to you in the form of dividends.

This typically makes their dividend yield a lot higher and more attractive than other dividend-paying stocks.

Another really big advantage of this is liquidity. If you ever needed the cash you can always sell your stocks very easily and use the money for something else

versus if you had a physical piece of real estate; selling it is al to tougher to do and that would typically involve a lot of fees that you would avoid having a REIT.

Finally the biggest and most attractive advantage of a REIT over a piece of real estate

is you don't have to do any operation or maintenance. That's taken care of by the company.

You're basically the owner. You collect the dividends like a rent check

but you don't have to deal with replacing leaking toilets, repainting any damaged walls, or replacing any busted windows.

This is great if you're not a particularly handy person or if you just don't want o deal with that.

You still get the stability of real estate investment without any of the headaches.

Now let's talk about some of the disadvantages. Well, if you're, say, a growth type investor

you could argue that a company that has to pay out most of its net income in the form of dividends is actually

a disadvantage because they can't use that money to grow their company and grow the value of their company.

A unique feature about the REITs is that their taxed a little bit differently so when you get your dividends as a shareholder you actually get taxed on those like they would be regular income.

This would be like receiving rent from a real estate property that you own, you would have to get taxed on that.

One thing that I would kinda say is a bit of a disadvantage of a REIT that you get the advantage of on a physical piece of real estate

is when you have a tenant you can develop a relationship with that person, develop a rapport

and you really can figure out if a certain tenant who is coming to rent your place is going to be a good tenant and take care of the place

and protect your asset. REITs of course operate more like a stock so you won't be able to have that

insight into what's going on in that particular REIT. Their stock price may fluctuate and cause a little bit of stress

because the public will react to certain things that happen and sell off at certain times and of course buy back in certain times.

Contrast that with what I've found - being a landlord - is that if you develop a good rapport with the tenant

and you find good, long-term tenants, you usually can keep them in the condo with a little bit of negotiation

even during turbulent times. So now let's talk about how to properly assess a REIT.

The thing we have to be careful about here is that some of the ratios that we typically use to assess a stock

aren't going to apply in our case here and I'm going to get into the math and why that is in a little bit.

We also have to remember that these stocks are taxed and governed differently than regular stocks

like the whole "90% of your income going to dividends" thing.

but the biggest difference that I found here is that because of the way a REIT

operates - and what I mean by that is they hold a lot of expensive assets but make their money off of the way they

operate those assets, which is the rental income -

you really have to understand how those numbers come out in the balance sheet.

You have to understand how depreciation is accounted for.

But the other thing too is that you have to understand that balance sheets and income statements don't capture market value.

So I'll get into all these differences, for now I'm going to use a REIT as an example

and go through some of the things that you have to look for.

The Canadian REIT we are going to assess today is going to be RIO-CAN.

According to WIkipedia RIO-CAN is the second largest REIT in Canada with over $14B in assets

and over 280 primarily retail types of properties.

It also has properties across Canada in most of the urban centres. One of the things that makes

RIO-CAN kind of unique is that it's mostly in supermarket and department store types of properties

but it's also kind of interesting because they also don't let any one tenant make up more than 5% of its portfolio which is

very good diversification. So with that we may as well get into the first

thing you should look at when you look at a REIT which is the types of properties.

Understanding the make-up of a REIT are very important obviously like you wanna know is it made up of commercial, industrial, residential? Like, what percentages?

So RIO-CAN for example is mostly in commercial real estate and it's commercial real estate is in

retail stores. So when you know the make-up of RIO-CAN how would be affected in certain scenarios like in a pandemic? Well

it wouldn't really like a pandemic because a lot of its tenants and stores would have to be shut down.

What about periods of good economic growth? Well when people have a lot of money and they have a lot of money to spend

retail stores thrive and RIO-CAN would thrive.

Now it is worth noting that RIO-CAN is getting into the residential market but it is a very small part of its portfolio right now.

It's trying to diversify a little bit there. So let's talk about the types of tenants. So like I said

RIO-CAN is mostly made up of supermarkets and department stores

and it doesn't let any one tenant make up more than 5% of its portfolio

where as other REITs may be very concentrated or have one

company that they really like to rent out to which you could argue makes them less diversified.

Being diversified is a great feature in case a certain tenant couldn't make rent.

RIO-CAN may be affected by things like store closures. So you may remember a

chain from Hudson's Bay Company called Zellers. Zellers use to be a tenant of RIO-CAN

so when Zellers closed down and shut all of its stores down that affected RIO-CAN.

If you're familiar with the story you'll also know that Target expanded into Canada by buying up a lot of those old Zellers stores

and opening them up as Targets. That was exciting and good for RIO-CAN

but of course eventually Target failed in Canada and that also affected RIO-CAN.

These would all be things that you have to keep in mind when invested in a REIT.

So one last question to ask is about the geographic location of your REIT.

How is that made up? How much of it is in urban centres and how much isn't?

RIO-CAN is concentrated mostly in urban centres but it's across the country.

So Vancouver, Toronto, even here in Calgary we have RIO-CAN properties.

Now this is a good thing for RIO-CAN because it has been able to make money off of property values

in the last few years because real estate has gone up in Vancouver and Toronto,

which has been great because real estate in buildings in Calgary has actually not been doing so well the last couple of years

so being geographically diversified has been a good thing for RIO-CAN.

Now, the next part of the video is going to get quite technical. We're going to get into the numbers and ratios

that you really want to look for. I'm going to go through some of the quarterly statement from Q1 for RIO-CAN

to give you some examples. Just a quick reminder to hit the Subscribe and the Like button if you guys are liking this so far and finding value in it.

At the end of this video I'll also give you guys a couple of REIT ETFs that you guys can look at and research

if you're not so interested in the details like this and you kinda want something simpler.

There are REIT ETFs for Canada that are worth looking at. Okay... Here we go...

So let's talk about funds from operations. Now, I'm going to start by talking about why you shouldn't use the PE ratio for a REIT.

So the P/E ratio is the price over the earnings per share. That's something we probably all know.

Now let's focus in on the earnings per share part.

The earnings per share is the net income minus any preferred dividends

over the total number of common shares.

Now we have to focus in on the "net income" part.

If we dig one step further the net income is revenue minus expenses.

And here's where REITs are a little bit different. The revenue is essentially the rent

that is collected off of all the properties for the REIT.

But the expenses will include all sorts of things including the depreciation.

Now, a company is required by code to depreciate any assets that they have

but real estate, we know, acts a little bit different than typical assets that another company might have like a factory or something.

So let's say you buy a property for $1M. Well, if you're a REIT and you're doing your accounting you have to depreciate some money off of that property every year as go.

So you may say that that property is only worth $900K after a year

if you choose to depreciate $100K off the $1M.

But we all know that property value doesn't work like that. Often times

actually the longer you hold the property it's actually worth more.

Whereas on your books you're actually making it worth less every year that you hold that asset.

So now you can see that the net income number is skewed which kind of skews your earnings per share

which kind of skews your P/E ratio. So that's why P/E's shouldn't really be looked at when you're assessing a REIT.

To get around this there's something called FFO which is "Funds from Operations"

and what this is is adding the depreciation back into the equation.

What you want to see is your FFO going up over time so let's go to the quarterly statement here from RIO-CAN.

We can see that the FFO is going up and despite having an increase in the number of units

the ratio is almost the same so yes RIO-CAN is making more money from operations that in Q1 of last year which is great.

Now you can take the FFO and put it over the total number of shares

to get a "Price per FFO" which would be like using a P/E but special for REITs.

So how we fairly assess the P/FFO for RIO-CAN using this quarterly statement

is we go back to the end of March, we get the share price which is $15.79 and we divide it by 4 times the per-unit FFO that's shown in this quarterly statement

because you have to multiply it per quarter.

...

That would give you 8.58 P/FFO ratio

and if we compared this to the industry average which is about 12 for Canada

it would actually tell you that RIO-CAN is a little bit undervalued when compared to it's peers.

The one thing to kind of pay attention to, though, is that FFO does miss a little bit.

It misses the capital expenditures that are required to

get and run a property. So this can be the cash to acquire the building

or even the cash to buy the paint and you know re-paint a bunch of the apartments if you needed to do that.

To include these types of expenses you'll see something called "Adjusted Funds from Operations."

Now, RIO-CAN does have a section here that specifically states that they do not use AFFO.

Instead they report ACFO, FFO and NOI which is net operating income

we'll talk about that next. And they're just saying in their opinion

those numbers give you the full picture so they don't do AFFO.

Now jumping down to the ACFO section you see it actually captures the maintenance here.

So the reason you want to look at these numbers together; the ACFO, the FFO

and the NOI is they give a full picture of the health of the company

and the ACFO will kinda tell you that after they've paid off their capital expenditures will they still have enough money to pay the dividend.

It's almost a like a free cashflow per share type of stat but for REITs.

Don't get too hung up by this. If the FFO, the ACFO, AFFO and NOI are all going up these are all good things for REITs.

So have a look at these numbers together just to get a full picture.

Now let's move on to the last number I want to talk about when evaluating a REIT which is the net operating income.

But first we gotta talk about why you wouldn't use Book Value or price to book ratio here

and i'm going to use the example of that house you bought for $1M.

Let's say after 5 years you depreciated $500K, $100K a year,

on the books your house would now be worth $500K.

But again we know that's not probably the reality. Well, one way to evaluate any piece of property

is to look at NOI which is net operating income. If you're evaluating different

real estate opportunities or trying to compare two different potential rental properties

that you're trying to get, yes you'd want to know the net asset value.

You could even figure out a CAP rate.

Now, we can't do that same sort of calculation with RIO-CAN. It's really difficult to figure out

the CAP rate that you would use across multiple urban centres and across multiple different types of properties.

So we're just going to stick to the NOI for now and talk about the NOI.

But what NOI is is essentially the income that you collect

from renting your properties minus everything except mortgage payments.

So that includes things like property taxes, maintenance fees, repairs, etc.

Anything that you would need to operate your properties.

So let's jump into the quarterly report I'll just highlight a couple of things here.

So you can see that the operating income is $175M. Remember these numbers are all in thousands.

They go ahead and they take off some of the adjustments here and list an NOI of $173M.

Also jump down to this section here that shows you the split of how much of that NOI is coming from commercial properties

versus residential. So this is what I was saying before where their residential

holdings are quite small compared to their commercial holdings.

Finally, this section here is kind of interesting because it lists the same property NOI which means

this is only numbers from properties that were held in both Q1 of 2019 and Q1 of 2020.

And you can see here in comparison that the numbers go up. This is actually really good because it means RIO-CAN

can produce more money out of the same assets year over year.

That was a lot of information but hopefully I've covered the basics here for you

and it's made some sense. Hopefully you guys understand why it's

important to understand the make-up of the properties in your REITs,

why it's important not to look at the P/E ratio but rather the P/FFO and how that's calculated,

the different types and ways you'll see funds from operations like AFFO and ACFO,

and finally why you wouldn't use price to book ratios but you would look at the NOI of a REIT instead.

Finally, if this is a lot of information and you're maybe not interested in this much detail

but you want to get into REITs there are two ETFs that I was kind of looking at

if that is more your thing. One of them is Vanguard which is VRE.TO

and the other one is an iShares one which is XRE.TO.

Those two REITs include RIO-CAN along with a lot of other Canadian REITs.

I haven't had a chance to research them but you can look into them if you're interested.

By the way if there's an interest in doing a video about ETFs and how they differ from regular stocks please let me know in the comments.

The next step now is to take this analysis and actually do a comparison between different REITs.

There are over 30 REITs in Canada that I could look at so I'm going to start to go through, pick the more popular ones,

And if you're interested in a REITs comparison video please also let me know in the comments below.

Anyways, guys, thanks for hanging in there. Until next time have a great week, spread the wealth, and I'll see you in the next one... bye.