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by Harry Domash
All About REITs
If you want to invest in commercial real
estate, you can do that via real estate investment trusts (REITs).
REITs trade like regular stocks, but they
don’t pay U.S. federal income taxes as long as they pay out at least 90%
of their taxable income to shareholders. On the downside, REIT dividends
are mostly taxed as regular income instead of the lower 15% capital
gains rate. So it’s best to keep REITs in tax-sheltered accounts.
There are two basic types of REITs:
Property REITs and mortgage REITs.
Property REITs own commercial real estate
properties such as apartment complexes, office buildings, or shopping
centers. Mortgage REITs don’t own properties; instead they invest in
mortgages backed by real estate, typically single-family residential
properties. In this article, we’ll focus on property REITs.
Property REITs provide the customary
management services associated with leasing properties such as apartment
buildings, shopping centers and office buildings. But they can’t operate
properties requiring a high degree of personal service such as hotels
and healthcare facilities. Instead, they must lease those properties out
to third-party operators.
You can use the free, easy-to-use screener at FINVIZ.com to find REITs.
Start by going to the FINVIZ homepage (finviz.com)
and then selecting Screener. FINVIZ calls its selection criteria
“filters.” On the Filters bar, select “All” to display all of the
available filters. Use the associated dropdown menus to select the
desired filter values.
Screen For REIT Candidates
I’ll fill in more details as I describe how to
promising REIT candidates. If you're not familiar
with the term, screeners are programs available on certain financial
websites that allow you to search through all listed stocks to find
those that meet your selection requirements.
Most property REITs specialize in one of these property categories:
retail, healthcare, lodging (hotels, motels, etc.), industrial, office,
or mixed industrial/office. Diversified REITs own properties in multiple
FINVIZ allows you to search for REITs by
those categories. Start by using the screener’s Industry menu to select
a category such as “REIT- Retail.”
Dividend yields are analogous to the interest rate on a savings account.
For a stock, your yield is the dividends you receive over a year divided
by the price that you paid for the stock. So your yield would be 10% if
you received $1 per share of dividends from a stock that cost you $10
per share. Currently, most property REITs are paying dividends equating
to 3% to 7% yields.
Use the Dividend Yield menu to define your
minimum acceptable yield. I specified “Over 4%.”
Look for Growth
established a satisfactory yield, dividend growth is the next most
important consideration. You win two ways if the dividends grow while
you own a REIT. The higher payouts increase your yield and the dividend
increase usually drives the share price higher.
To find the REITs with the best dividend growth prospects, you must
pinpoint those with the fastest expected FFO growth. What's that?
Because property owners must deduct
non-cash depreciation expenses when calculating earnings, even if the
property is, in fact, appreciating in value, reported income is
unrealistically reduced by those charges and doesn’t measure the actual
cash flow generated by the properties. For that reason, the REIT trade
association created a measure called “funds from operations” (FFO),
which reflects the actual cash profits generated by a REIT's operations.
Although property REITs typically report both net income and FFO, the
analyst’ earnings estimates that you see on financial sites for REITs
are typically FFO per share estimates rather than earnings per share.
REITs are slower growers than regular growth stocks. Typically, about 5%
to 10% annual FFO growth is about all that you can expect.
Use the “EPS Growth Next Five Years” menu
to select “over 10%.” Try cutting that number to "over 5%" if you want
to see more candidates.
Thanks to the huge trading commissions that they generate, institutional
investors such as mutual funds have access to information that you and I
never see. Thus, it makes sense to stick with stocks that the big money
likes. Institutional ownership measures the percentage of shares held by
these savvy players.
Require “over 40%” Institutional Ownership.
Not Too Cheap
Cheap stocks get that way because many investors see problems ahead.
Whether they are right or wrong, low trading prices signal added risk,
which you don’t need.
For Price, specify “over $5.”
FINVIZ tabulates stock analyst buy/sell ratings into these categories:
strong buy, buy, hold, sell, and strong sell. If anything, analysts tend
to be overoptimistic. To be on the safe side, pass up stocks that the
analysts are avoiding.
Require “Buy or Better” for Analyst
Stocks tend to move in trends. That is, as stock that has been steadily
moving up is likely to continue in that direction, and vice-versa. Thus,
your best candidates are those that are trending up.
Comparing a stock’s share price to its
moving average (average closing price over a specified number of days)
will tell you which way a stock is moving. Uptrending stocks are trading
above their moving averages, while downtrending stocks are trading
below. The 200-day moving average measures a stock’s long-term price
Use the “200-Day Simple Moving Average”
menu and specify “Price Above” to limit you list to uptrending REITs.
That's it. Click
here to see what the screen turns up today (The default category is
retail. Use the Industry dropdown menu to select other categories).
Spend some time understanding a
REIT's business by reading its quarterly earnings press release
well as the management discussion portion of its quarterly and
annual SEC reports which can be found on Yahoo and
other sites. The more
you know about your stocks, the better your results.