The most common way of calculating the relative value of a REIT such as AvalonBay Communities (AVB) is the price-to-FFO[1. fund-from-operations] multiple. FFO is widely used because it is the main earnings metric for REITs similar to earnings per share, or EPS, in other industries. The price-to-FFO multiple ratio is equivalent to the price to earnings, or PE, ratio used in other industries.
Peer group price-to-FFO multiple
A closer look at AvalonBay Communities’ trailing-12-month price-to-FFO multiple shows that it is in line with its historical valuation. Over the last eight years, AvalonBay Communities’ price ranged between 9.7x and 33.2x of its FFO, with a current price-to-FFO multiple of around 22.1x. AvalonBay Communities experienced its lowest price-to-FFO multiple during the housing crisis, whereas it recorded its highest multiple in July 2011.
At this multiple, AvalonBay Communities’ stock is trading at a higher multiple compared to all of its peers except Essex Property Trust (ESS), which is trading at a multiple of 22.9x. The industry average Price-to-FFO multiple is 18.9x. Meanwhile, Equity Residential (EQR) is trading at 21.1x, and UDR (UDR) at 20.4x. Finally, we have Camden Properties Trust (CPT) trading at a price-to-FFO multiple of 16.1x.
Higher multiple for AvalonBay Communities
Historically, a higher price-to-FFO multiple for AvalonBay Communities meant that it was able to provide consistent capital value return along with steady dividend yield to investors. Currently, AvalonBay Communities is offering a dividend yield of 2.85%, which is lower than its close competitors like Equity Residential (EQR) at 2.92%, but higher than Essex Property Trust (ESS) at 2.52%. The industry average dividend yield is 3.22%. The iShares Residential Real Estate Capped ETF (REZ) invests 8.25% of its portfolio in AvalonBay Communities.
In the next part of this series, we will discuss investment in REITs through ETFs.