How Should You Analyze REIT Stock Equity Commonwealth (NYSE:EQC)?

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Equity Commonwealth is a US$3.9b mid-cap, real estate investment trust (REIT) based in Chicago, 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. I’ll take you through some of the key metrics you should use in order to properly assess EQC.

See our latest analysis for Equity Commonwealth

Funds from Operations (FFO) is a higher quality measure of EQC's earnings compared to net income. This term is very common in the REIT investing world as it provides a cleaner look at its cash flow from daily operations by excluding impact of one-off activities or non-cash items such as depreciation. For EQC, its FFO of US$100m makes up 50% of its gross profit, which means over a third of its earnings are high-quality and recurring.

In order to understand whether EQC 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 EQC to pay off its debt using its income from its main business activities, and gives us an insight into EQC’s ability to service its borrowings. With a ratio of 12%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take EQC 8.5 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.

I also look at EQC'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 1.92x, EQC is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.

I also use FFO to look at EQC's valuation relative to other REITs in United States by using the price-to-FFO metric. This is conceptually the same as the price-to-earnings (PE) ratio, but as previously mentioned, FFO is more suitable. In EQC’s case its P/FFO is 39.61x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.

Next Steps:

As a REIT, Equity Commonwealth offers some unique characteristics which could help diversify your portfolio. However, before you decide on whether or not to invest in EQC, I highly recommend taking a look at other aspects of the stock to consider:

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

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.