Apartment real estate investment trust (REIT) companies make money by renting apartments, which they own and manage. There are about 17 million apartment units in the U.S., with a median rental income per unit of approximately $650 per month. The market for multi-family housing is highly fragmented, and the top 7 publicly traded REITs account for less than 4% of the overall share.
Apartment REITs compete for tenants not only with other apartment operators, but they also compete on the relative attractiveness of owning a home versus renting an apartment. When home prices are high, renting becomes more attractive (and vice versa). Interest rates determine the attractiveness of mortgage financing, and when they are high, demand for apartment rentals increases as financing a mortgage becomes more expensive.
It is also important to note that, by law, REITs must distribute at least 90% of its cash flow to shareholders every year in the form of a dividend. When interest rates rise, so do demands for investment yields on dividends, which can depress a REIT's stock price.
A special metric called Funds From Operations or FFO is used by REIT investors and analysts to evaluate REITs instead of relying on standard financial metrics like net income or EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). FFO is obtained by adding back expenses like depreciation to net income and excluding any income derived through the one-time sale of assets.
FFO = Net income + depreciation - gains from sale of assets.
FFO is preferred as a valuation metric because it gives a better picture of cash flow from operations than net income, which includes non-cash related expenses such as depreciation and amortization. Some analysts prefer to use another metric called Adjusted FFO, which subtracts capital expenses that are required to maintain the portfolio of properties and amortization from net income to give an even better picture of true cash flow generated from operations. Capital expenditure or Capex is normally added to the value of an asset on the balance sheet and then depreciated on the income statement over the life of the asset.
Beyond FFO, the following three metrics could provide investors with some additional big picture insight,
Earnings yield of REITs is obtained by dividing Funds From Operations (FFO) by price. The earnings yield of the S&P 500 is defined as earnings divided by price, essentially the inverse of the P/E ratio. I have expanded upon each of these metrics below.
|Company||Apt. Units (2006)||Addressable Market (Units)||Local Market Share||National Market Share||Occupancy Rate (2006)||Operating Margin||Revenue/unit|