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The debt to equity ratio measures the (Long Term Debt + Current Portion of Long Term Debt) / Total Shareholders' Equity. This metric is useful when analyzing the health of a company's balance sheet.
The optimal D/E ratio varies by industry, but it should not be above a level of 2.0. A D/E ratio of 2 indicates the company derives two-thirds of its capital financing from debt and one-third from shareholder equity.
A good debt-to-equity ratio is at a minimum of 70% debt and 30% equity, or 2.33. Most experts advise not to invest in a property with a debt-to-equity ratio of 5.5 or higher. The reason? A higher debt-to-equity ratio means greater financial risk to investors because the property's debt far exceeds its equity.
A current ratio above 1.0 is generally considered to be healthy.
In a side-by-side structure, a REIT operates alongside other investment vehicles, such as private equity funds or other non-REIT structures. This arrangement allows investors to choose between traditional REIT investments and alternative investment strategies offered by the other vehicles.
How must a real estate company be organized to qualify as a REIT? A U.S. REIT must be formed in one of the 50 states or the District of Columbia as an entity taxable for federal purposes as a corporation. It must be governed by directors or trustees and its shares must be transferable.
To qualify as a REIT, a company must have the bulk of its assets and income connected to real estate investment and must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.
Since real estate investment can carry high debt levels, the sector is subject to interest rate risk. D/E ratios for companies in the real estate sector, including REITs, tend to range from 1.0 to over 8..