Weighted Average Cost of Capital (WACC) & Spread Accretion Explained
Weighted Average Cost of Capital (WACC) & Spread Accretion: A REIT's Cost of Capital is the blended cost of its debt (bond coupon yield) and equity (AFFO yield). When a REIT acquires real estate at a cap rate higher than its WACC, the transaction is accretive and boosts FFO per share.
Institutional Analysis & Context
REITs are balance sheet compounders that must continuously raise external capital because they distribute 90%+ of taxable income as dividends. The spread between the acquisition cap rate and blended WACC is called the Investment Spread. A wide positive spread allows premier REITs to grow external cash flows year after year.
Formula & Calculation Breakdown
| Metric Component | Definition & Application |
|---|---|
| Cost of Equity | AFFO per share divided by Current Share Price (or CAPM model) |
| Cost of Debt | Weighted average interest rate on notes, bonds, and bank term debt |
| Investment Spread | Acquisition Cap Rate minus WACC |
Real-World Calculation Example
Flagship REITs Exemplifying This Metric
Analyze how top public REITs perform across this dimension in the live market:
Frequently Asked Questions
Why does a higher stock price help a REIT grow?
When stock prices trade higher, the REIT's cost of equity drops. Management can issue fewer shares to raise capital, making acquisitions significantly more accretive to existing shareholders.
What is an 'External Growth Story' in REIT investing?
It refers to a REIT expanding its portfolio and earnings through property acquisitions funded by accretive equity and debt issuance, rather than relying solely on internal rent bumps.
What happens if a REIT's WACC exceeds property cap rates?
The REIT is trapped. Acquiring properties would dilute earnings per share. Management must halt acquisitions, sell non-core assets, or buy back its own discounted stock.