The real estate sector comprises different groups of companies that own, develop and operate properties, such as residential land, buildings, industrial property and offices. Since real estate companies usually buy out the entire property, such transactions require large upfront investments, which are quite often funded with a large quantity of debt.
One metric that investors pay attention to is the degree of leverage the real estate company has, which is measured by the debt-to-equity (D/E) ratio.
D/E Ratios in the Real Estate Sector
The D/E ratio for companies in the real estate sector on average is approximately 352. Real estate investment trusts (REITs) come in a little higher at around 366, while real estate management companies have an average D/E at a lower 164.
Real estate companies represent one of the most attractive investment options due to their stable revenue stream and high dividend yields. Many real estate companies are incorporated as REITs to take advantage of their special tax status. A company with REIT incorporation is allowed to deduct its dividends from taxable income.
How to Evaluate the D/E Ratio
The D/E ratio is a metric used to determine the degree of a company's financial leverage. The formula to calculate this ratio divides a company’s total liabilities by the amount of equity provided by stockholders. This metric reveals the respective amounts of debt and equity a company utilizes to finance its operations.
When a company’s D/E ratio is high, it suggests the company has taken an aggressive growth financing approach with its debt. One issue with this approach is additional interest expenses can often cause volatility in earnings reports. If earnings generated are greater than the cost of interest, shareholders benefit. However, if the cost of debt financing outweighs the return generated by the additional capital, the financial load could be too heavy for the company to bear.
D/E ratios should be considered in comparison to similar companies within the same industry.