I like real estate companies since I find them easy to value. And in times of bear market, they can become undervalued.
Many also pay out a very stable dividend and some even pay out a quarterly one. Knowing how to value real estate stocks can be a good tool for building a strong dividend portfolio.
We will separate this guide into two categories:
- Quantitative (numbers data)
- Qualitative (non-numerical data)
I go more for the number since it's easier to compare them and non-numerical is harder to grasp the risks.
At least according to myself.
List of everything in this basic guide:
A higher valuation is a higher possible profit. But you have never actually realized it until you have sold it. It’s kinda wrong to say you have earned $ X yet because someone wants to buy it for that price, but you didn't sell it.
It’s understandable why it’s hard to distinguish higher valuations from profits. And that’s why real estate companies can display a “wrong” P/E.
It's often better to use Net Rental Income (NRI) since it's the income from the rent after all expenses related to the real estate. However, taxes and interest rates are not calculated in NRI by default, so keep that in mind.
Basic real estate companies
|NAV Discount||P / NRI||D / E|
|NAV Discount||P / NRI||D / E|
Important Multipliers for Real Estate Companies:
Net Asset Value (NAV)
This is the company's assets (real estate) but also means the liquidation value. So if we buy at a NAV discount and the company gets bought up or liquidated we should still stand to get a profit.
For me, this has happened several times since I always buy under the NAV value for this reason.
Net Rental Income (NRI)
This is what I would call earnings. Since it’s what a rental property is profit-generating. After all expenses such as renovation, administrative, and taxes.
Dividend Payout Ratio (NRI Style)
If we take the dividend / NRI we get what % of the NRI that’s being paid out as a dividend. Rental companies can pay out a rather high dividend. But it’s very important to see if it’s sustainable or if they had a higher dividend because of a property sale.
Since most real estate companies rely on debt to get the leverage it’s important to understand how much it is. Because if interest was raised the company can lose money and be forced to liquidate.
Interest Coverage Ratio
This is how many times over the company can pay its interest. And it’s calculated with EBIT / Interest expense. But since earnings in real estate are not ideal it could be better to take the Rental Income instead.
I skip to calculating this sometimes and focus on a better debt-to-equity and NRI. Since I assume if they earn a lot and have low debt their interest can’t be that hard to pay.
Growth is also a factor. Rental growth, growth in form of valuations or acquired new properties.
But most real estate companies I have valuated don’t have so much growth so I value them on pure value principles. And buying them for what they perform now and hope they perform at least as well in the future.
EPRA (European Public Real Estate Association)
EPRA has defined several key ratios that aim to provide investors with consistent and transparent information to assess the performance and financial health of real estate companies. They could be very similar to the key ratios listed above, but easier to find in annual reports.
Some of the key EPRA ratios include:
- EPRA Earnings: This ratio adjusts the reported earnings of a real estate company to exclude the effects of fair value adjustments on investment properties. It provides a more stable measure of the company's underlying operating performance.
- EPRA Net Asset Value (NAV): EPRA NAV is a measure of a real estate company's net assets, calculated by adjusting the reported net asset value to exclude certain items that are deemed to be non-recurring or not reflective of the company's ongoing operations. It provides a more meaningful valuation of a real estate company's underlying properties.
- EPRA Net Initial Yield (NIY): This ratio calculates the annualized rental income generated by a real estate property, expressed as a percentage of its market value. It is used to assess the investment yield of a property and compare it with other properties or market benchmarks.
- EPRA "Like-for-Like" Rental Growth: This ratio measures the organic rental growth of a real estate company's property portfolio by excluding the effects of property acquisitions or disposals. It provides insight into the underlying rental performance of the company's properties.
This is more art than science for me since I have a hard time understanding the real-life importance of this kind of information.
But I have some basic understandings and can apply them somewhat to my investments.
Knowing something can be a higher risk is also information we can put into use.
Types of Real Estate
There are several types of real estate types. Residential, commercial, industrial, raw land, and special use.
Some types of real estate are harder to get sell because there is lower demand and a lower amount of buyers.
More people are looking to buy a house than there a people that look to buy a mall.
And some other is deemed riskier since the demand is expected to be lower. Shops for example are deemed riskier. Since the market believes online shopping is the future.
If for example a shop is expected to get fewer customers. Then the rents could be lowered since it’s less attractive.
Some types of real estate are less attractive. And we have to take that into account when evaluating companies.
Buying real estate in emerging markets can provide great growth. And increased valuation but they come with high risks.
Emerging markets often come with problematic governments. That sustains more corruption, economic, political, and other problems.
And all can affect real estate. A problematic country could, for example, go into war. And sustain great economical damage that makes people less likely to have money for rent.
The country could even get invaded and the real estate bombed so it becomes worthless.
This is a worst-case scenario. But as we understand there could be risks with investing in some emerging markets.
Related article: Investing in real estate: Rental properties vs. REITs