Essex Property Trust, Inc. is a US$20b large-cap, real estate investment trust (REIT) based in San Mateo, United States. REITs are basically a portfolio of income-producing real estate investments, which are owned and operated by management of that trust company. They have to meet certain requirements in order to become a REIT, meaning they should be analyzed a different way. Below, I’ll look at a few important metrics to keep in mind as part of your research on ESS.

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REIT investors should be familiar with the term Fund from Operations (FFO) – a REIT’s main source of cash flow from its day-to-day business activities. FFO is a higher quality measure of earnings because it takes out the impact of non-recurring sales and non-cash items such as depreciation. These items can distort the bottom line and not necessarily reflective of ESS’s daily operations. For ESS, its FFO of US$827m makes up 80% of its gross profit, which means the majority of its earnings are high-quality and recurring.

In order to understand whether ESS has a healthy balance sheet, we have to look at a metric called FFO-to-total debt. This tells us how long it will take ESS to pay off its debt using its income from its main business activities, and gives us an insight into ESS’s ability to service its borrowings. With a ratio of 15%, the credit rating agency Standard & Poor would consider this as significantly high risk. This would take ESS 6.78 years to pay off using operating income alone. Given that long-term debt is a multi-year commitment this is not unusual, however, the longer it takes for a company to pay back debt, the higher the risk associated with that company.

I also look at ESS’s interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it’s better to use FFO divided by net interest. With an interest coverage ratio of 3.75x, it’s safe to say ESS is generating an appropriate amount of cash from its borrowings.

In terms of valuing ESS, FFO can also be used as a form of relative valuation. Instead of the P/E ratio, P/FFO is used instead, which is very common for REIT stocks. In ESS’s case its P/FFO is 23.81x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.

Next Steps:

Essex Property Trust can bring diversification into your portfolio due to its unique REIT characteristics. Before you make a decision on the stock today, keep in mind I’ve only covered one metric in this article, the FFO, which is by no means comprehensive. I’d strongly recommend continuing your research on the following areas I believe are key fundamentals for ESS:

1. Future Outlook: What are well-informed industry analysts predicting for ESS’s future growth? Take a look at our free research report of analyst consensus for ESS’s outlook.

2. Valuation: What is ESS worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether ESS is currently mispriced by the market.

3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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