Tag Archives: FFO

So, You Want To Be A Real Estate Mogul? (SLG & BXP)

Do you want to be a big-time office landlord with an ownership stake in some big-city trophy office buildings? It’s more possible than you think. Shares of two of the largest publicly traded office REITs, SL Green (SLG) and Boston Properties (BXP), are trading at reasonable prices. Here’s the skinny on them.

SL Green is New York’s largest owner of commercial real estate, including ownership of 28.2 million square feet of space and another 18.3 million square feet of buildings securing debt and preferred equity investments. The firm has interest in 106 Manhattan buildings (around 12% of the office market) and 15 more suburban New York City buildings. These include a slew of midtown Park Avenue and Fifth Avenue locations. On top of this, the firm owns over 2 million square feet of Manhattan retail space with a mix of tenants that include Nordstrom, Burberry, Prada, Giorgio Armani, Tissot, Lowe’s, and CVS.

For all its attractive space, SL Green’s stock has languished lately. After having peaked at just under $120/share in the middle of 2016, it trades in the high $80 range right now. But that can be an opportunity for investors. The firm has generated $6.61 in funds from operations (FFO) over the past four quarters. That means it trades at around a modest 13 times FFO. Investors should remember that FFO is a REIT metric that adjusts net income for property sales and depreciation. It’s not a perfect cash flow proxy because all real estate involves some depreciation that a good analysis must add back. But FFO allows analysts and investors to take a first stab at cash flow, and to make comparisons between one REIT and another.

The firm has increased year-over-year same-store revenue impressively for the past four quarters — 2%, 7.4%, 7.8%, and .6%. It’s hard for SL Green’s tenants to complain that the rent is too darn high because they need or want to be centrally located in Manhattan. That’s why the firm still boasts higher than 95% occupancy. The rent is going up, and that’s good for shareholders.

SL Green paid a dividend of $0.8125 per share on October 15, 2018. That translates into a 3.7% dividend yield. The dividend soaks up only around half of the FFO the firm generated for the past four quarters, which means it’s well covered.

One big risk investing in firm carries is its new development project, One Vanderbilt Avenue. This is a $3 billion trophy property that is estimated to be completed in 2020. If the economy slows to the point where the firm has trouble leasing the building, that would spell trouble for shareholders. Still, the company has a strong record of growth since its IPO in 1997, and it emerged from the financial crisis in decent shape.

SL Green’s larger, more diversified competitor, Boston Properties has also suffered declines in its stock price recently. The stock peaked at around $140 per share in mid-2016, and trades at under $120 now. Instead of focusing on New York City, Boston Properties owns 164 office buildings (48 million square feet) in Boston, Los Angeles, New York, San Francisco, and Washington, D.C.

The firm has produced $6.20 per share of FFO for the past four quarters, and its stock trades at 18 times that. The firm is paying a $0.95 dividend, which appears save given its last four quarterly FFO readings of $1.49, $1.49, $1.58, and $1.64.

One negative is that the firm has reported only minuscule increases in year-over-year same-property net operating income over the past four quarters. Reports indicate that the Washington, D.C. office market is soft and where the firm has 10 million square feet or a little more than 20% of its property. Still, the firm’s diversified portfolio on both coasts give it an advantage and perhaps a stability that the market seems to like given its higher Price/FFO multiple.

Neither of these firms are paying a whopping dividend – 3.7% for SL Green and 3.2% for Boston Properties. The 10-year U.S. Treasury, by contrast, is paying around 2.7%, by contrast. Still, these landlords have the ability to increase rent in the future. You may not get rich owning these buildings at their current price, but you’ll collect a decent dividend that seems safe, and can be increased in the future.

REITs: Slightly Better Than Broad U.S. Market, But Still Not Cheap

When I wrote an article on REITs for the Wall Street Journal in early 2017, I used a research report from Research Affiliates in Newport Beach, CA to argue that the asset class was overpriced and poised to deliver 0%-2% or so real returns for the next decade.

My article sparked a lot of mail and controversy. One reader reply underneath my article on the WSJ website said “Among equity REITs traded on stock exchanges there has literally never been a 10-year period in the history of REIT investing when real total returns averaged 0% per year (or worse) as [John Coumarianos’s] approach predicts.”

Another letter, which the Journal published as a reply to my article, from Brad Case of the National Association of Real Estate Investment Trusts (NAREIT) strangely had the exact same language about REITs never producing such a poor 10-year return as the letter written by someone of another name under the column on the website. Case’s formal, published letter went on to say, “The current REIT stock price discount to net asset value suggests that returns over the next 10 years may exceed inflation by around 8.15 percentage points per year on average.”

The decade isn’t up, but now, two years in, let’s see how things are going for REITs. Also, what’s the forecast today? Have things improved? After we assess recent returns, let’s go through the forecast again to see if things look any better now.

Not A Great Two Years For REITs

In 2017, two major REIT index funds – the Vanguard REIT Index fund and the iShares Cohen & Steers REIT Index ETF — produced a nearly 5% return each.  Considering that the CPI (consumer price index) was up 2.1% in 2017, that’s about a 3% real or inflation-adjusted return.

In 2018, the iShares fund delivered a 5.29% return through October, while the Vanguard fund delivered a 2.03% return through October. So far inflation is running at an estimated 2.2% for the year, according to the Minneapolis Fed. That means REIT real returns for 2018 are in the 0%-3% range, depending on which index you use. For both 2017 and 2018, we are a far cry from Case’s 8.15% real return forecast.

Start With Dividend Yield

The analysis advocated by Research Affiliates was simple. First, start with “net operating income” (NOI) or rent minus basic expenses. NOI a good indication of the cash flow a property or a collection of properties are delivering. Investors take this number and divide by the price of a property to determine what they call a “capitalization rate.” In effect, that resembles an earnings yield (earnings divided by price) of a stock. Mutual fund investors can substitute dividend yield of a REIT-dedicated fund.

For my original article, the dividend yield of most REIT index funds and ETFs was around 4%. Now it’s closer to 3%. The iShares Cohen & Steers REIT ETF yields less than 3.2% right now, while the Vanguard REIT Index fund lists a current effective yield of 3.23% and a yield adjusted for return of capital and capital gain distributions over the past two years at 2.13%.


The second component of a return forecast is a property upkeep component. Real estate requires capital – not only for the initial purchase, but also for maintaining the property. Things are always breaking and obsolescence always threatens landlords who must update kitchens, bathrooms, and other aspects of their properties. It’s true that with some property types, tenants are responsible for some upkeep and improvement, but that isn’t always the case. Research Affiliates figures 2% of the cost of the property per year, is a decent round number to use in a return forecast. Unfortunately, that wipes out most of the 3% dividend yield investors are currently pocketing.

So far, we are running at a 0 or 1% real annualized return for the next decade.

Price Change

The last component of real estate valuation and return forecasting is the most speculative. Where will properties trade in a decade? Nobody knows for sure, but Research Affiliates estimated in early 2017 that commercial property was priced 20% above its long term trend. If prices remained at that level, investors would capture the 4% yield minus the 2% annual upkeep or 2% overall. If prices reverted to trend, investors would have to subtract enough from net operating income adjusted for upkeep to bring future returns down to 1.4%.

Currently on the Research Affiliates website, the firm forecasts REITs to deliver a 2% annualized real return for the next decade. That’s about where the forecast stood at the beginning of 2017. It’s worth noting that although that’s a low return, it’s actually a better forecast than the firm has for U.S. stocks, which it thinks won’t deliver any return over inflation for the next decade.

Gut Check

It’s often useful to take multiple stabs at valuation. So, in the spirit of providing a gut check, I supplemented this dividend-upkeep-price analysis with a simple Price/FFO (funds from operations) analysis. REITs have large, unrealistic depreciation charges, rendering net income a mostly useless metric. FFO, which adjusts net income for property sales and depreciation is a more accurate cash flow metric. FFO isn’t perfect either because it doesn’t account for different debt loads of different companies and because it doesn’t account for maintenance costs, but it’s a uniform metric that almost all REITs publish.

Of the top-20 holdings of the Vanguard Real Estate Index fund VGSIX, Weyerhaeuser and CBRE didn’t publish FFO metrics. The average of the other 18 companies was 20. That’s a pretty high multiple for REITs, which are slow growth stocks.

Three Opportunities In The Retail Wasteland

It’s no secret that malls are under pressure from e-commerce and Amazon. Even strip malls anchored by supermarkets and stores like Target and WalMart are struggling as shoppers buy more necessities and staples online. But some shopping center REITs’ stocks have declined so much that they’re worth a look from investors. Three of the largest – Brixmor, KIMCO, and Weingarten are yielding 5.70% or more.

Covering Dividends & Interest Payments

First, all three companies can cover their dividends with funds from operations (FFO). FFO is an important REIT cash flow metric that’s useful for understanding dividend coverage. It adjusts net income for property sales and depreciation, the latter of which can be an unrealistic charge in real estate. It’s not perfect because some capital is required to maintain property every year, but it’s a decent start to see if companies can maintain their current dividends. Our three  companies are producing FFO that’s at least 38% higher than their current dividend payouts.

Second, none of our companies is carrying a dangerous amount of debt. Their fixed charge (bonds and preferreds) coverage ratios are all over 3x. The typical cash flow metric used to calculate coverage is EBITDA or earnings before interest, taxes, depreciation and amortization. Again, that’s imperfect because it doesn’t include maintenance capital expenditures, but at 3x or more it’s fair to say our companies don’t have unreasonable amounts of debt.

Same Property NOI Growth & Property Quality

Another important metric in real estate is if companies are experiencing same-property rent and net operating income (NOI) growth. Our companies are. Brixmor, however generated the lowest same property NOI growth for the second quarter of 2018 (the most recent available), and that may be why its stock is trading at the lowest FFO multiple and delivering the highest current yield.

One possible reason for Brixmor lagging in this category is that its sprawling property portfolio includes malls in less upscale areas. When looking at the amount of annualized base rent (ABR) each firm had from each city or metropolitan area, and Brixmor had only 24% of its rent come from Los Angeles, Houston, metropolitan New York City, Chicago, Miami, Washington, D.C., and San Francisco. By contrast, Weingarten had 34% of its rent come from those locations and KIMCO had nearly 39% of its rent come from those locations.

Additionally, Brixmor may have the least desirable top tenants. Weingarten and KIMCO count Home Depot and WholeFoods as top-10 tenants, but Brixmor doesn’t. Brixmor has more discount stores in its top-10, including Burlington and Dollar Tree.

Overall, all three companies are healthy, but KIMCO and Weingarten have a more attractive tenant lineup that make paying up for them worth it. Incidentally, this exercise also shows why investors need to be wary of advisors who say to them “I can get  you x% yield.” Higher yield usually comes with higher risks or, in this case, inferior real estate and tenants. You can have any yield you want, but you have to be cognizant of the risk associated with each yield.