The Hoyt Model: an Introduction

The Hoyt REIT Model ("model") is a unique proprietary model which both values REITs and assesses risks on a variety of dimensions. It does this by decomposing the cap rate used to value the REIT in the securities market.

The decomposition is in three major areas:

• Real Estate,
• Capital Structure, and
• Management.

This decomposition enables the Hoyt staff to value the underlying real estate on Main Street, then value the real estate in REIT ownership under the existing capital structure of the REIT, and finally to value the REIT shares on Wall Street.

Typical models

The typical models for REIT securities analyses forecast earnings, funds from operations, or some variation of profitability and cash flow including funds available for dividends. They also go after a target price for a near term. Some even go as far as to forecast a rate of return for the near term. The focus of analyses is short term with long term considerations implied.

The Hoyt Model

• Capitalizes the income flow from real estate in order to get values of the real estate owned by the REITs,
• Adjusts the cash flow for capital structure and then values the real estate in the REIT form of ownership within the REIT's capital structure without management, and
• Further analyzes the income flow to value the existing management in place along with valuing the real estate in REIT form within the REIT capital structure.

In addition, to being a pricing model, the Hoyt Model is a risk rating model in which the decomposition of the cap rate results in valuing risks. Thus, there is a series of cap rate adjustments which reflect risks associated with the variables to which the cap rate is decomposed. (See a simulated example in Exhibit I.)

Exhibit I

The difference in cap rates in the market and the warranted cap rates, as indicated by the Hoyt Model, identify overvalued and undervalued REITs. Exhibit III shows summary adjustments and the difference between the market and warranted dividend cap rates. These REITs' cap rates may be plotted and graphically represented as a scattergram. (See Exhibit III.) The spread between market cap rate and warranted cap rate may be represented by a bar chart. The valuation difference is shown in Exhibit IV, Valuation Difference.

Exhibit II

Exhibit III		Exhibit IV

Exhibit V - Valuation Difference

Risk Profile Concept and Analyses

Real estate is useful in a mixed asset portfolio because real estate risks occur in different combinations than the risks of other assets. The three most important risks in a real estate investment are

• Getting one's money back, sometimes called business risk,
• The loss of purchasing power (price level risk), and
• The chance of loss from quickly converting to cash (liquidity risk).

The Hoyt Model structures the decomposition of risk, as earlier discussed, by real estate, capital structure, and management risks. It also may be used to assess diversification among REITs focused on three dimensions of business risk, price level risk and liquidity risk. That risk combination analysis is being developed for REITs as well as stocks and bonds so that the mixed asset portfolio may be diversified by risk rather than ownership interest, i.e., the four quadrant system. The present system, however, decomposes the risks utilizing the real estate, capital structure, and management set of risks.

REITs cluster as to risks so that their risk profile is somewhat different from directly owned real estate and from other small cap stocks. However, when looking at the universe of REITs, the risk clusters of individual REITs with common characteristics may vary widely. While there was variation in liquidity and sensitivity to price level change, the biggest variation is in business risk. This business risk is most closely associated with the local economy, and the market for property services by property type as well as the existing tenancies. Thus, REIT portfolios may be constructed with substantial diversification on the business risk dimension.

A portion of the Hoyt portfolio of REITs shows the following ranges of risks:

Exhibit VI

Representation of risk classifications may be made by bar charts. The charts use a nominal scale of zero to three along which the potential risk is rated. The bar chart is a continuum. The ratings of malls is shown in Exhibit VII.

Exhibit VII

The scale may be divided into low, medium, high, or a star system. The star system inverts the risk rating to become a quality rating. Thus, four stars is the lowest risk category. One star is the highest risk category. Two and three stars split the middle category. See Exhibit VIII.

Exhibit VIII

The Model provides similar information on the following REITs:

Other Aspects

Portfolio Context

The Hoyt REIT Model values REITs and assesses risks based on numerous variables. By profiling the risk characteristics and quantifying the premium for the cap rate, it provides a basis for selection of individual REITS and for REIT portfolio construction.

In the REIT portfolio context:

• The basic model can be used to pick undervalued stocks,
• The model may be used to identify pure plays,
• The risk profile may be used for diversification, and
• Portfolios may be constructed for
• Income and/or
• Growth.

These portfolio strategies are described in a monograph being written.

Analyses of Individual REITs

The Hoyt Model may also be used for

• Policy analyses by REIT management,
• Merger and acquisition analyses, or
• Selection of REITs by institutions having real estate to exchange for REIT shares.

This model is developed as an analytical system to assist in understanding REIT values and risks. The information is believed to be reliable. However, no warranties are made with regard to the data or the judgements even though best efforts have been used in good faith.