Oppenheimer Funds has produced a commentary on REITs that looks more like marketing material than serious analysis to me. The piece is slickly put together with charts and graphs showing how REITs have performed in the past. There is scarcely any mention of how they’re priced now, however.
So we did a simple calculation of Price/FFO of the top-10 companies in the Vanguard REIT Index Fund. (FFO or funds from operations is a classic REIT cash flow metric that adjusts net income for depreciation and property sales.) The top 10 components of this fund, which tracks the MSCI US REIT Index, soak up nearly 46% of its assets. So nearly half the index is in the top-10 names we evaluated.
We found that the top-10 components have an average Price/FFO of 21, a rather high number by historical standards. Investors are paying $21 for every dollar of cash flow. Another way to look at this is investors are getting less than 5% of FFO yield for their investment in highly levered companies that produce relatively low returns on invested capital. And FFO doesn’t account for maintenance capital expenditures. The chart below shows the details.
Here and there, one might find a mildly cheap REIT after searching hard, but in no way is the index cheap in aggregate.
Finally, here is our case for shorting Avalon Bay Communities:
(Full disclosure: I’m short AvalonBay Communities.)