REITs and InvITs: distributions, coverage, and why earnings barely matter

A real-estate investment trust owns a portfolio of prime office buildings, fully let to blue-chip tenants, throwing off a river of rent. Its reported profit is modest - almost embarrassing next to the value of the properties - and on a price-to-earnings basis (share price divided by annual profit) the REIT would look wildly expensive. That modest profit tells you virtually nothing, because a REIT is bought and read not for its earnings but for the cash it distributes. The single most-quoted number in a company's accounts is close to irrelevant here, replaced by a different one entirely: the cash available to pay out to unitholders - a REIT's investors, who hold units rather than shares. illustrative

The reason is depreciation. A REIT owns buildings, and accounting requires it to depreciate them - to charge a large slice of their cost against profit every year, as if they were wearing out. But well-located commercial property does not wear out the way a machine does; it holds its value, and often rises. So the depreciation charge is a real cost on the P&L and a fiction in economic terms, and it drags the reported profit far below the cash the business actually generates. Reading a REIT on its earnings, as one would an ordinary company, produces nonsense - the earnings are an accounting residual, not the business.

This module reads a REIT - and its infrastructure cousin the InvIT, the same trust structure holding roads, power lines or pipelines instead of buildings - through the numbers that matter: net distributable cash flow, the cash available to unitholders; distribution coverage, whether that cash comfortably covers what is being paid out; and the portfolio metrics - occupancy, lease expiry and loan-to-value - that decide whether the distribution is sustainable. Accounting profit is left where it belongs for a REIT: to one side.

See the gap between reported profit and distributable cash first.

Net distributable cash flow is the real measure. Take the operating profit, add back the non-cash depreciation, subtract the interest on the debt and the maintenance capex needed to keep the buildings competitive and let, and you get net distributable cash flow, or NDCF - the cash the REIT actually has to pay out. It is far higher than the reported profit because the depreciation, the biggest charge on the P&L, is not a real drain. NDCF is to a REIT what earnings are to an ordinary company: the measure everything else refers to. The distribution comes out of it, and the distribution yield - distribution divided by unit price - is the REIT's headline return.

Distribution coverage is the safety margin. A REIT can pay out up to its NDCF, and distribution coverage - NDCF divided by the distribution - is how much cushion sits behind the payout. Coverage of 1.2 times means the REIT generates 20% more cash than it distributes, a buffer for a vacancy or a rent dip. Coverage of 1.0 means it pays out every rupee, with no margin; coverage below 1 means it is distributing more than it earns in cash, topping up from debt or reserves, which cannot last. A high yield covered only 1.0 times is far riskier than a lower yield covered 1.3 times - and the coverage, not the yield, is where that risk shows.

Behind the cash sit the properties, read on three numbers. Occupancy is the share of space let; falling occupancy means falling rent and falling NDCF. WALE - the weighted-average lease expiry - is how long the leases run: a long WALE means secure, visible rent, a short one means near-term re-leasing risk. And loan-to-value (LTV) is the debt as a share of the property value - the REIT's leverage. A high, rising LTV means the distribution and the unit value sit on a thin equity cushion, and because LTV is measured against valuations that can fall, a downturn can breach the covenants attached to the loans and force a distribution cut or a dilutive equity raise (issuing new units, which shrinks each existing holder's stake). These three, with NDCF and coverage, are the whole read.

Reading a business on distributable cash rather than earnings is unusual, and it inverts the instinct built on almost every other company. For a manufacturer the reported profit is the business, cash-checked; for a REIT it is an accounting shadow of it, depressed by a depreciation charge that reflects no real cost. Set four income-holding businesses side by side and the question "which number do I read?" has a different answer in each.

For a REIT the reader must set aside the instinct to value on earnings and the price-to-earnings multiple - which for a REIT is uninformative - and read instead on distributable cash, its coverage, and the yield that cash supports, a valuation logic closer to a bond than a growth stock. This is the clearest case in the market where the earnings line should simply be ignored, and a reader who insists on reading a REIT the way they read a manufacturer will find it either bafflingly expensive on a P/E basis or inexplicably generous on yield, without understanding either.

Read the composite office REIT's fifth year. Its reported profit after tax is ₹980 crore. On a portfolio worth many thousands of crores that looks thin, and on a P/E basis the REIT would appear wildly expensive. Ignore it. The depreciation charge of ₹1,100 crore - larger than the reported profit itself - is a non-cash convention on buildings that are holding their value, not a real economic cost. illustrative

Now read the cash. Net distributable cash flow is ₹1,890 crore - nearly double the reported profit - because the depreciation is added back and only ₹190 crore of genuine maintenance capex is subtracted along with interest. That ₹1,890 crore is what the REIT actually generates, and the distribution of ₹1,700 crore is paid from it, covered 1.11 times. The coverage is the safety margin: the REIT throws off 11% more cash than it distributes, a modest but real cushion. The distribution yield of 7.7% is the headline return, and it is a cash return funded from NDCF, not from earnings or borrowing.

Then read the portfolio behind the cash. Occupancy rose to 92% - the buildings are nearly full, so the rent is secure. The WALE is around six years, so the rent is visible well into the future with limited near-term re-leasing risk. And LTV is a conservative 25% and falling, so the debt against the properties is modest and the equity cushion is thick - a fall in property values would not threaten the structure. Put together, this is a healthy REIT: strong cash generation, a well-covered distribution, a full and long-leased portfolio, and low leverage. None of it is visible in the ₹980 crore reported profit; all of it is in the cash and the portfolio metrics. That is the habit to build - ignore the profit and the P/E, read NDCF as the measure and coverage as the margin, then read occupancy, WALE and LTV underneath.

Distribution coverage tells you the cash cushion this year, but not whether the maintenance capex behind it is honest. NDCF is struck after subtracting the capex needed to keep the buildings competitive and let, and a REIT under pressure to show a higher distributable figure can under-invest - deferring the refurbishments that keep tenants - which flatters this year's NDCF and coverage at the cost of falling occupancy later. A high coverage on a portfolio starved of maintenance capex is borrowing from the future, and the ratio alone cannot reveal it; the occupancy trend and the age and quality of the portfolio have to be read alongside.

Nor does the current distribution tell you what happens when the leases expire. A long WALE gives visible rent for years, but leases eventually roll, and whether they re-let at higher or lower rents depends on the property market, the location and the supply of competing space - none of which is in the NDCF. A REIT can look secure on a six-year WALE and face a cliff when a cluster of leases expires into a weak market, so the lease-expiry profile and the outlook for rents in its specific micro-markets matter as much as today's occupancy.

And the leverage, read today as an LTV, is only as safe as the property valuations it rests on. Those appraisals are estimates that can fall sharply in a downturn - pushing LTV up, breaching covenants, and forcing distribution cuts or dilutive equity raises exactly when conditions are worst. A REIT with a comfortable 25% LTV in good times can find it at 40% after a valuation reset. A forced equity raise at the bottom of a property cycle is the kind of damage there is no recovering the lost value from - the dilution is permanent, done at the worst possible price, which is why the resilience of the valuations and the headroom to the covenants are the real questions a comfortable current LTV only half answers.

When a REIT's distribution looks attractive, a sharp analyst probes its coverage and the capex behind it: "Distribution coverage is about 1.1x - how much of the maintenance capex has been deferred, what's your leasing outlook as the near-term expiries roll, and where does LTV go if valuations fall 10%?" The analyst is testing whether the distribution survives a downturn, not just today.

A good answer, verbatim-style.

"Fair to stress-test it. Coverage is 1.1x and we've fully funded maintenance capex - in fact we stepped up refurbishment at two assets this year, which is why NDCF isn't higher. On expiries, about 12% of leases roll over the next two years, and re-leasing spreads are currently positive, around 8%, though we'd flag one market where it's flat. On leverage, LTV is 25%; a 10% valuation fall takes it to about 28%, well within our 40% covenant, so no forced action. So the distribution is covered from genuine cash with capex funded, and there's real headroom on leverage."

It confirms the capex is funded, gives the near-term expiry and re-leasing outlook, and stress-tests LTV against the covenant. It lets you judge sustainability, not just the current yield.

An evasive answer, verbatim-style.

"We're pleased to deliver another quarter of stable, growing distributions, reflecting the quality of our portfolio and our disciplined management. Our balance sheet is strong, occupancy is healthy, and we remain confident in delivering attractive, sustainable returns to our unitholders. The outlook remains positive."

Reassuring and unspecific. It never gives the coverage, never addresses deferred capex, offers no re-leasing spread or expiry detail, and cites a "strong balance sheet" without the LTV or its covenant headroom. "Sustainable returns" is asserted, not demonstrated - and a REIT under-investing to flatter its distribution would say exactly this. The follow-up that settles it is rarely asked: "What was maintenance capex this year versus the prior three, and what is your re-leasing spread on next year's expiries?" Watch what happens when it is allowed to stand. The silence is the tell - either the capex has been trimmed to prop up the distribution, or the near-term expiries face a weakening rental market.