In light of REITs’ fall, we took a measure of their valuation by calculating Price/FFO ttm for the top 15 constituents of the Vanguard REIT Index Fund (VGSIX). (FFO or funds from operations is net income adjusted for GAAP depreciation, which is often unrealistic for a REIT, and property sales. So it’s something like operating cash flow.) We discovered that REITs are still trading, on average at 20x FFO ttm — and that’s not including maintenance capex or cash required to make long-term improvements to the properties.
Although here and there one might find a bargain, it’s hard to justify buying the index or an index-hugging sector fund at current prices even after the recent drop. The table below tells the valuation story (click on it to enlarge it). The quarterly FFO numbers are on a diluted per-share basis.
Of course, REITs could stabilize if the yield on the 10-Yr US Treasury stops rising, and yield-starved investors find their confidence to take risk again. Still, we don’t think conservative investors have a significant margin of safety at 20x trailing FFO.
Granted REITs are still up around 7% for the year, judging from the Vanguard Index Fund, and that’s a healthy margin over inflation (though perhaps not as impressive on a tax-adjusted basis). But they’re now trailing the broader market significantly and they may not stay in the black for the year at these prices.