REITs Capital Structure analysis 

REITs must pay out 90% of their taxable income to shareholders annually in the form of dividends. In practice, most REITs distribute 100% of their taxable income to avoid paying corporate-level income tax. As a result, REITs rely on Debt and Equity financing for property acquisition and growth.

As we have it, Capital means Debt and Equity. Thus Capital Structure can be rewritten as Debt and Equity Structure analysis. Thus, you can see that Capital Structure analysis is very important to REITs & Stocks.

What is capital structure analysis about?

Capital Structure analysis is an evaluation of debt and equity financing used by a company. The intention is to determine the combination of debt and equity a business should have to achieve optimal capital structure.

Why is capital structure analysis important to investors?

Don’t worry it’s not going to be technical. Optimal Capital structure although rarely talked about on investing forums. Optimal Capital structure is a very important concept in corporate finance. Although for us individual retail investors, it is impractical for us to figure out what is the Optimal Capital structure the REIT’s Manager should operate under. We can look at some ways to detect Capital Structure risk.

What are Capital Structure risks?

To put it simply when REIT/Firm’s Capital structure risk is high, It implies that the firm has too much debt(or over-leverage).If the company has poor/inconsistent cash flow from operations, it has a high risk of defaulting on its debt. Thus, such firms are considered risky investments best avoided. 

Here is a list of Capital structure Risk Financial metrics Investors used.

  1. Gearing ratio/leverage ratio
    Gearing ratio or leverage ratio is just another word for debt to equity ratio. A high gearing ratio means that the firm is heavily relying on debt to expand or fund its business operation.
  2. Cost Of Debt
    This value is the weighted averaged effective interest rate payable.
  3. Interest coverage ratio
    Highlight a business’s cashflows ability to cover its debt expenses. Any value lesser than 2.5 times is a red flag.