The other day, Donna asked me how to figure out when a REIT is on sale. Here's the Phil Town response:
REITs are very different from regular stocks. They don't grow their earnings by increasing their share of market. In fact, they don't even keep their cash flow usually. They send it out in the form of a dividend to the REIT shareholders. Therefore we can't value the business as a business based on future increasing surplus cash flow, which is what we do with regular businesses.
Instead we determine the value of the REIT by the value of the real estate the REIT owns.
A simple and fast way to get a handle on the value of the REIT real estate is to look at the book value per share. Theoretically that number is the value of the real estate minus the loans.
Of course, it might not be accurate because the actual value of the real estate is what it would sell for, not what an accountant appraises it at. Still, it's as good as we can get without going deeper into this than I want to go.
A rough rule of thumb of the retail or Sticker Price of a REIT is its book value per share.
For you Investools users, you'll need to look at the bottom of the balance sheet and divide the number of shares that year into the equity that year to get book value per share.
If you are using MSN Money, they publish it as book value per share as per my book.
One of the problems with real estate is that you can't always find something to buy at a 50% discount to its Sticker Price. In fact, you'll almost never find that in REITs.
However, sometimes you get some deals. In 2000 there were REITs selling for about 80% of Sticker (as determined by book value per share). Taubman, TCO, was selling for $7.50 per share with an end of 1999 bvps of $9.09. About 82% of Sticker. And Taubman is a great REIT.
Even better, it also gave shareholders a $1.28 dividend at the end of 1999. That's 17%. So that's what a good deal looks like in a REIT. Forget a 50% MOS. Ain't gonna happen. If you see something like this, go for it.
Chances are you won't see anything near this today. Real Estate has gone off the wall. It's up there with the 1999 NASDAQ in terms of being overvalued.
Don't believe me? Let's look at TCO today: $1.57 dividend paid eoy 2006. But the stock was priced at $62. That's a 2.5% dividend. And the bvps at the eoy 2006 was $2 a share.
Obviously the market thinks TCO is worth more than $2 - mostly because it's a premium shopping center REIT... and maybe its real estate is worth a lot more than it's showing on the books. Morningstar is rating it at $35 stock so there is something here I'm missing.
From a dividend point of view, a REIT should throw off a lot more than 2.5%, which in TCO's case is a historic low. That should tell you that the price is WAY too high.
REITs have risk and so have traditionally give investors something like a 6% to 8% dividend. If we use 7% for TCO (to take another tack at pricing it today), what price should I pay if the entire payable eoy 2006 cash is $2.54? (NOTE: the actual dividend was $1.57 and the rest is being used by TCO to fund development and hopefully generate a better return in the future).
Divide $2.54 by 7%. I get $36. And now we know how Morningstar got to their valuation.
Bottom line is you should look at real estate through two lenses:
what's the real estate worth?; and
what's the value based on a dividend?
In either case, TCO is WAY overpriced, and I think if you look into it you'll notice that most of the other REITs are as well. Which was why I emphasize that the price you pay is so critical to making a good investment. Although TCO is a great REIT, it's overpriced and we can't buy it.
By the way, if you are looking for a good deal on real estate, tell me what you think about HOT - Starwood Hotels. Lots of real estate AND a very interesting business.
Now go play.
