Which ratio is best for evaluating REITs?
The performance of residential REITs can be best evaluated with the price-to-funds-from-operations (or FFO) ratio. This ratio gives an idea as to how much an investor is paying per unit of profit generated by the company. This ratio is used mainly for evaluating REITs and has the same meaning as that of the price-to-earnings ratio used for companies in other industries.
AvalonBay Communities (AVB) has the highest premium in terms of its price-to-FFO ratio among the three residential REITs discussed. The stock is trading at a price-to-FFO ratio of 22.13x. The higher-than-expected results during the recently concluded 2Q17 have made investors optimistic about the stock. Moreover, the company’s recent strategic expansion and disposition activities have boosted investor confidence about the company’s fundamentals.
Equity Residential (EQR) currently trades at a price-to-FFO multiple of 21.50x. The stock also has seen recent price gains, as investors are encouraged by the robust 2Q17 results. The company has repositioned its properties in six coastal markets with high demand for rentals. Moreover, management has raised its outlook for fiscal 2017, as it expects the momentum to continue.
Essex Properties (ESS) trades at a price-to-FFO multiple of 21.81x. Similar to EQR, ESS has also raised its fiscal 2017 FFO and income guidance and is enjoying consistent rent growth backed by the positional advantage of its properties in Class A cities.
ESS trades at a premium with respect to its EV-to-EBITDA ratio compared to the other two residential REITs. While ESS trades at an EV-to-EBITDA ratio of 25.45x, EQR trades at 21.86x and AVB trades at a multiple of 24.70x.
The REITs pay almost 90% of their profit in the form of dividends and share buybacks. Thus, the dividend yield of the companies is also an important metric for evaluation.