The Intelligent REIT Investor Guide

CHAPTER 12Breaking Down the REIT Balance Sheet

“Ben Graham's principle of always returning to the financial statements will keep an investor from making huge mistakes. And without huge mistakes, the power of compounding can take over.”

—Michael Price

We're not quite done discussing blue‐chip REITs yet, which is why we need to address balance sheets. As I've already brought up a time or two, private equity real estate buyers like to use debt to partially finance their acquisitions. There are good reasons for this, especially for small‐scale operators. Since debt is a way to circumvent equity capital constraints, it allows owners to stretch their equity over multiple properties, therefore lessening the risk of any single one. Plus, interest payment deductibility creates a tax shield.

For private real estate investors, outside debt also tends to be cheaper than outside equity. That's because the stability and predictability of those cash flows, along with its low price volatility, make real estate a desirable collateral asset against which lenders are comfortable extending credit. Finally, so long as the property's return exceeds the debt's interest rate, adding more debt can actually increase the equity investor's rate of return. This is known as positive leverage.

It would be tempting to conclude then that using large amounts of debt could be equally beneficial for REITs. However, unlike private real estate investors, they can access reasonably priced equity in well‐functioning ...