Guide to REIT valuation
REITs are a public channel of real estate ownership. Hence, a common means for valuing REITs is to consider a REIT’s Net Asset Value (NAV), which refers to the market value of a REIT’s properties less debt. When a REIT trades at a price lower than NAV per share, it is trading at a discount to NAV and can be considered attractively priced, especially when it is also trading at a lower price-to-NAV relative to other REITs.
Because most REITs pay out most of their earnings as dividends, price-to-earnings and dividend yield are sometimes used as relative valuation metrics. It should be noted though that rental support arrangements and certain capital expenditures can distort a REIT’s sustainable income and dividend yield. For this reason, analysts often make adjustments such as stripping out rental support and adding back depreciation to derive Funds from Operations (FFO) or Adjusted Funds from Operations (AFFO). This price-to-FFO or price-to-AFFO multiple is then used to value REITs.
Beyond current valuation, analysts also consider future prospects for the REIT. Without going into the minutiae of by property and by tenant analysis, investors can inform their views by considering economic conditions of the geographies the REIT is operating in and demand-supply dynamics of the REIT’s property sector.
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