How to use WALE when evaluating REITs?

So in a previous Q&A we addressed AFFO and the price-to-AFFO multiple to measure the relative valuation of a REIT with respect to our best approximation of its net income, but now we are going to tackle WALE to get a better overall picture of what’s going on under the hood with the quality of a REIT’s leases.

WALE stands for “weighted average lease expiry”, where we try to boil all of a REIT’s leases with its various tenants down into one representative number, weighted by the gross leasable area (GLA) attached to each lease. A very simple example will explain this best. Lease A is for 10 years and 100 sqm and Lease B is for 5 years and 900 sqm. The total area leased out is 1000 sqm, but the average lease expiration is not 7.5 (10 years + 5 years / 2), since the 10-year lease only applies to just 100 sqm.

In this case, Lease A accounts for 10% of the GLA, so it counts as 1 year (10 years * 10%), and Lease B accounts for 90% of the GLA, so it counts as 4.5 years (5 years * 90%). Add these two together, and you get the WALE for our imaginary REIT at 5.5 years. WALE is one of those things that isn’t super important until it absolutely all of a sudden very much is. A great example is with any kind of large-scale crisis, like say... COVID. Short-term lease renewals that come up during the lease (or near to it) are vulnerable, but long-term leases that exist in a time horizon beyond the crisis are less so. It should be noted that not all leases are created equal, and it’s possible for long-term clients to back out of a lease as well (or for the government to provide methods of rent relief that may impact a REIT’s bottom-line). It’s possible to represent WALE as a function of either rent revenue or GLA. I prefer rent revenue, as I think this is a better metric for use across REIT types.

MB BOTTOM-LINE

 Like we discussed with AFFO, there is no One REIT Metric To Rule Them All; it’s just like evaluating the long-term prospects of any other stock. You need to get different perspectives to try and triangulate where the REIT is compared to its peers, and where it might be going. Investing in a high-yield REIT with super-high occupancy and very short WALE might be fine in boom times, but that might be a terrible combination for challenging periods like the one we just went through. POGO clients are the perfect example here, as they’re the ultimate fair-weather friends in the REIT world right now. A REIT that is stuffed with POGO clients is most likely to have a lower WALE.

Depending on your long-term thesis, this could be a good or a bad thing, but I think you can see how it would be good to know but not the only thing you’d want to know before investing in a REIT. WALE can help determine the reliability and steadiness of a REIT’s dividend. Some of my friends use it as a kind of “health check” barometer, as a sort of stand-in for overall tenant and building quality. Now, thanks to REIT Tracker, you can, too if you want. Or not! Just remember to make sure to do your own research, too.

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Merkado Barkada's opinions are provided for informational purposes only, and should not be considered a recommendation to buy or sell any particular stock. These daily articles are not updated with new information, so each investor must do his or her own due diligence before trading, as the facts and figures in each particular article may have changed.