Tag Archives: real estate investment trusts

Pssst. Want To Own The Empire State Building?

I know what you’re thinking when you read my title – that you should run away from anyone trying to sell you a famous bridge or building. But real estate investment trusts (REITs) sometimes own landmark structures, and you can too if you decide to buy their shares. One such REIT is Empire State Realty Trust (ESRT), named after the most famous building in its portfolio, the Empire State Building, and its shares look reasonably priced.

Empire State Realty Trust owns 14 office and 6 retail properties in and around New York City totaling 10.1 million rentable square feet. Suburban properties are in Westchester County, NY and Fairfield County, CT. Occupancy for the entire portfolio runs nearly 88.8%, down from just under 90% from a year ago. Greater New York office is at 87.6% from 91.25 a year ago, while standalone retail is at 94.4% from 99.4% a year ago. The landlord’s largest retail-related tenants are Global Brands, Coty, PVH Corp., and Sephora. Other large tenants include LinkedIn, Li & Fung, HNTB Corporation, and Legg Mason. No tenant accounts for more than 6.7% of the firm’s annualized rent.

Over the past four quarters, the firm has collected around $730 million in rent. This includes a whopping $131 million in revenues from the Empire State Building Observatory, up from $111.5 million in 2014. More than 3 million people visit the observatory every year, though the number of visitors declined by 4%-5% over the past three quarters compared to the same quarters from last year. Around $500 million of the rent is from the Manhattan office portfolio.

Over the past four quarters, the $730 million in revenue has resulted in $282 in funds from operations. The latter is a real estate cash flow metric that adjusts net income for property sales and depreciation. That’s just under $1 per the roughly 297 million shares outstanding. At its current price between $15 and $16 per share that means that stock trades at a Price/FFO multiple of around 16. Some publicly traded REITs, especially the larger apartments with coastal property, are trading closer to 20. Empire State Realty Trust’s competitor in NYC office space, SL Green, is trading at around a 14 Price/FFO multiple.

The firm’s cash flow is easily enough to cover its dividends. The firm has paid out $0.10 per quarter in dividends recently, and its FFO has been between $0.19 and $0.29 per quarter over the past four quarters. However, it seems as if the firm is conserving cash in order to redevelop some of its property. Some analysts classify the firm’s property as between class-A and class-B, and a glance at the tenant roster shows an absence of high-powered New York financial and law firms. The good news is the firm has the luxury of being able to spend the money required for redevelopment. Its financial condition is strong, as it’s able to cover interest payments by nearly 6x with cash flow.

Despite a reasonable valuation and a strong financial position, passive investors in Class A shares – the ones most investors would be purchasing — have much less control over the company than investors might like. The Class B common stock, when accompanied by 49 operating partnership units, entitles an investor to 50 votes on all matters on which Class A common stockholders are entitled to vote, including the election of directors. REITs often have structures unfriendly to shareholders, most frequently poison pills that make a takeover or change of ownership difficult because of the automatic issuance of new stock when a shareholder accumulates a concentrated position. This separate share class arrangement is an extra problem for ordinary shareholders.

Owning Empire State Realty Trust isn’t a slam-dunk investment. But you’re getting paid nearly 3% to own the Empire State Building and other New York City-area properties, while you wait for the firm to redevelop its other Manhattan buildings. There are worse places to allocate capital right now.

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.