After having written a post about using REITs as a tool for real estate investors to discover which kinds of properties to invest in. I had a person ask me which REITs had lower leverage (based on the comment to that post). Since you can purchase a REIT that specializes in one type of property, is there a sector that is generally lower in leverage than others. Maybe, but I find that you can discover firms that are run properly, whether they are buying office buildings, hospitals, or hotels. To help you pick a REIT, I thought that I would go over some guidelines that I use.
Firstly, I am not a financial advisor nor some stock guru (I am a home inspector); I am only explaining my method, so you can build upon it to find your own REITs. I will not explain the terminology in this post, because there are better sites for those definitions. I think that Mr. Bogle’s advice of investing in index funds is best for a little investors, but I also think that REITs can be a great introduction into real estate investing for those who do not want to deal with owning an actual piece of property. Here we go.
Where can you go to find a stock? Since I have a brokerage account, I use the research tools available to me on that site; however, there are many free stock screening tools to be found on the internet. (Type in that phrase into your favorite search engine to find a list). In the past, I have used the one provided by Kiplinger’s which I really liked. Today, I checked what would come up in a search, and I found one from Zack’s Investing site that was really good. Take some time to learn how to set up your search, and maybe try a few different ones to see what they come up with on a list.
What should I be looking for in a REIT? To find my parameters, I looked at a set of metrics which made sense to me, and wrote down those numbers for twenty different companies, which I then averaged out. Here is the metrics list:
P/E (price to earnings) ratio: average = 24.03 I made my range 20 to 28 I felt that this range showed that there was not too much unqualified belief in the stock’s performance, nor a feeling of bad performance by other investors.
Debt over Equity: average = 2.18 to play it safe, I decided to look for firms that had a number lower than 2.18 (most REITs take on debt to buy real estate, but you do not want them to be overburdened by it).
Yield %: average = 3.72 I decide to look for yields greater than 3.5% (what can I say, I like dividends, but all REITs have to pay out there profits)
ROE (return on equity): average = 11.69 I decided on a range from 8 to 15
ROA (return on assets): average = 4.09 I decided on a range from 2 to 6
P/B (price to book) ratio: I chose a range of 1,21% to 6%, because I associate that figure with more value stocks.
I also focused on smaller firms (under $10billion), because I thought that they had room to grow, and I chose only one firm to represent a sector of REITS, beacause I was not looking to buy a great many stocks. I looked at the fluctuations in price over time (anything that was swinging wildly up and down was out); I also looked at the stock price history (there had to be a good steady climb over ten years). A note on the ROE and ROA: I felt that if management was going too far below the average, they were not doing a good job. If they were too far above average, they may easily loose control of the situation like a bubble popping. That is why I came up with a range that I was comfortable with. Lastly, I investigated news articles about the firm. If I felt that something was amiss, or not to my personal liking, I scratched their name of the list.
Do these criteria guarantee me success? No; stocks will always carry a degree of risk, but I think that these factors help me choose firms that are doing a good job. I once worked as a senior manager where I could make a good deal of money in bonuses if I met certain financial numbers. I frequently saw managers fudging numbers in the belief that they could make it up the next quarter, so they could obtain that bonus which they needed to pay off bills. I one time discovered $10,000 in unpaid invoices for a small retail location that were hidden to make that spot appear more profitable. It took me three months, but I made the location profitable through wise planning. I came away from the experience realizing that many managers feel that it is easier to fudge than to spend the time to work. Considering the current financial crisis, I think that I cannot always trust financial numbers, but I think that these ranges play it fairly safe; however, you have to judge for yourself when picking stocks.