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Richard Shaw, QVM Group (52 clicks)
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Equity REITs have made a strong move lately. We have expressed our doubts about the wisdom of that move (Are REITs Ahead of Themselves?), and wonder about the quality of the underlying trusts.

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To look behind the REIT fund surge to constituent REITs, we screened for the more financially sound individual trusts.

REITs face various risks, which include among others:

  • trends for their property type
  • trends for their geographic exposure
  • lease defaults in a tough economy
  • lease non-renewals in a tough economy
  • debt refinancing in a tighter lending environment with declining asset values (probably higher loan-to-value ratios and possibly lower overall tenant credit quality)
  • variable debt interest rate increases.

We are focusing on the debt and refinancing related issues here.

The list below (as of August 7, 2009) contains 63 equity REITs that have better Long-Term Debt-to-Capital ratios than the rest. If you are seeking individual REITs instead of a diversified REITs fund, there may be securities in this list that could be of interest.

[Note that we did not do any pro forma analysis -- just a current financial snapshot -- you need to take the analysis further and forward. This is just a starting point for consideration.]

The list is sorted by the Long-Term Debt-to Capital ratio, and shows the Times Interest Earned ratio, and the Return on Equity over the past twelve months, as well as the Market-Capitalization.

REITs with an LTD/Capital ratio over 60% were omitted.

Standard & Poor’s says that those with LTD/Capital ratios of 35% or less are in strong financial positions (shaded green). S&P says those with ratios between 35% and 50% have adequate financial strength (shaded yellow); and that those with ratios greater than 50% have limited financial flexibility (shaded pink).

For Return on Equity, we shaded those under 3% pink for poor; shaded those between 3% and 8% yellow for potentially acceptable for this period; and shaded those greater than 8% green as good for this period.

For Times Interest Earned, we shaded those under 1 pink as poor; shaded those between 1 to 2 yellow as potentially acceptable; and shaded those greater than 2 green as acceptable.

For Market-Capitalization, we shaded those under $100 million pink as insufficiently liquid; shaded those between $100 to $250 million yellow as probably insufficiently liquid for most investors; and shaded those over $250 million as possibly greater than the minimally acceptable liquidity (although $500 million to $1 billion may be your minimum instead).

As a practical matter, participation in the smaller REITs is better attempted through diversified funds which are themselves liquid. Liquidity is a key attribute of investments if you intend to use stop loss orders, because when a stop is triggered, it becomes a market order. A market order in a thinly traded security will likely produce unsatisfactory results, perhaps quite unsatisfactory results

Disclosure: we do not own any REITs or REIT funds in any accounts at this time.

Source: Searching for Financially Sound Equity REITS