The saying "one size fits all" is not tossed around in the
world of investing very often... and that's for good reason.
Risk appetites, investment horizons and financial goals mean
portfolios can -- and usually do -- look different from person to
person. Going a step further, each asset in those portfolios
carry their own quirks that require tailored analysis.
With the wide range of products trading on public exchanges
these days, it's important to know that a worthwhile metric in
one industry may not reliably apply to the next.
One shining example of this is EPS, or earnings per share.
Many investors use EPS quarter after quarter to rate their
holdings, but if you used that metric to value one industry in
particular, you'd be way off base.
Real estate investment trusts
have been a cornerstone of my trading portfolio for years now.
While you may already be familiar with REITs and their inner
workings, would you know how to properly value and compare
Correct REIT appraisal centers on a key metric known as funds
from operations, or FFO. EPS, in comparison, is based largely on
net income that has had depreciation removed from it. Since real
estate often keeps its value or appreciates, we need to add that
number back in to get a more accurate view.
The basic formula for FFO is as follows:
Funds From Operations = Net Income + Depreciation +
Amortization - Gains on Asset Sales + Losses on Asset Sales
This helps us find the true cash flow from operations for
REITs. Strong FFO supports existing processes, bolsters new
acquisitions and ensures investors will be paid future
To give FFO some real world context, let's look at a case
study with one of the hottest REIT sectors right now:
What exactly is causing self-storage REITs to reach all-time
1. Mortgage rates are still relatively low.
2. Home and rental prices are increasing, while income growth
hasn't kept pace.
3. Flourishing job markets (such as those in Texas) are boosting
All of these result in transitions where people might find
themselves in need of extra storage space. Whether waiting to
close on a new home, downgrading due to higher rents or packing
away items during a move, there are plenty of reasons to seek out
the services of self-storage centers.
The three major players in this space are
Public Storage (NYSE:
Sovran Self Storage, Inc. (NYSE: SSS
Extra Space Storage, Inc. (NYSE:
Fortunately, all three trusts reported earnings at the end of
July, giving us a fresh set of FFO numbers to analyze. On a per
share basis, PSA comes ahead with an FFO of $1.97. SSS takes the
second spot with an FFO per share of $1.00, having disappointed
analysts by $0.05. EXR rounds out the bottom at $0.64 per
It's important to note the size differences, however. PSA
dwarfs the competition with a market cap of over $30 billion. SSS
and EXR are just fractions of that size, carrying capitalizations
of $2.5 billion and $6.1 billion, respectively. So how are we to
compare the three effectively?
Just as you can divide price by earnings to arrive at a P/E
ratio for stocks, you can divide price by FFO to put each REIT on
the same playing field. With that in mind, I've annualized the
most recent quarter's FFO numbers to compute the forward P/ FFO
ratios of PSA, SSS and EXR.
|Public Storage (
|Sovran Self Storage, Inc. (
|Extra Space Storage (
In the above context, we see that PSA is actually overvalued
compared to the other two REITs, with SSS trading at the biggest
discount. We could actually make a case for going long SSS and
shorting PSA in a pairs trade until valuations are more in
Risks to consider:
FFO should be your main starting point when analyzing REITs,
it remains just one piece of the puzzle. Occupancy rates,
dividend growth, M&A activity, etc. should all be factored in
to make the most informed decision possible.
Action to take-->
Understanding the key metrics that drive your investments is
essential to running a good portfolio. In the case of REITs,
tracking the latest FFO numbers will keep your fingers on the
pulse of performance. As far as self-storage REITs go, P/ FFO
ratios are high given the strong price growth in the past few
years. However, a conservative entry on SSS could yield some
respectable gains if a pull-back were to occur in the near
Interested in REITs
? My colleague Nathan Slaughter has recently discovered a
high-yield income investment that allows regular investors to
invest in real-estate like America's wealthy. These "
," as we call this special group of REITs, allow anyone to invest
in real estate and earn yields of 12% or higher -- and it takes
no more than $500 to get started. To learn more about this
special asset class, I urge you to
check out his latest report here