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A Better Way to Value REITs

We're giving active property managers the respect they deserve.

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For years, a fierce debate has raged among fundamental investors who follow property companies over the best way to value these unusual entities, most of which are known as real estate investment trusts, or REITs.

The battle has been pitched between two camps. On one side, the vast majority of REIT investors have relied almost exclusively on the net-asset value (NAV) model, which I've written about in the past. The idea behind this model is that a REIT is worth no more or less than the value of the buildings that it owns minus the debt that it owes. To estimate the value of the REIT, investors simply estimate the rental income the firm can earn over the coming year and divide by a discount rate, known as the "cap rate." In this valuation approach, the company is worth just as much dead as it is alive, liquidated versus a going entity. In the other camp, a much smaller minority of investors relied on some sort of discounted cash-flow model. The idea here is that a REIT stock--like any other investment--is ultimately worth the sum total of its future cash flows, discounted back to the present.

Craig Woker does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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