There are many different things you should consider before you dive right in and put your money into a specific investment. Doing an analysis of the potential investment's value can help you figure out whether it's a good choice or not. This process is called valuation, and it helps investors determine an asset's current and projected worth.
Conducting an analysis of the value of an investment means you'll need to know some of the metrics of the company as well as some information about the company's management. This goes for companies in any kind of industry including real estate. This article looks at price-to-earnings ratios (P/E) and how they're measured in the real estate industry.
Key Takeaways
- Price-to-earnings ratios can help investors decide what stock price is appropriate given the earnings per share generated by a company.
- It is common for established real estate companies to trade at 35x to 45x forward earnings because REITs are evaluated with different metrics compared to other companies.
- Investors should remember that property depreciation can skew a REIT's earnings figures.
What Is Price-to-Earnings Ratio?
The price-to-earnings (P/E) ratio is an important element of fundamental analysis. It is a commonly cited valuation metric that can help investors decide what stock price is appropriate given the earnings per share (EPS) generated by a company.
P/E levels vary due to several factors including the growth rate of the specific company compared to the general market and to its peers, the growth of the industry and its life cycle stage, market capital conditions, and macroeconomic conditions. Also, valuations are different across industries. The earnings part of the P/E ratio can refer to trailing or forward estimated earnings, and forecast earnings are typically more influential for valuation purposes.
The P/E ratio tends to be a favored analytical method is because it gives earnings a relative price tag. This helps determine when there are discounts to be had or if share prices become too unaffordable.
Trailing P/E
The trailing P/E is a valuation based on the previous 12 months of actual earnings. In order to calculate it, we take the current share price and divide it by the trailing EPS from the last 12 months. This earnings figure can be found on both the annual report and the income statement. Some investors and analysts prefer using this figure because it's more accurate, as it uses actual figures. But keep in mind, past performance doesn't necessarily point to future
Forward P/E
Rather than using actual figures from the past, the forward P/E uses guidance of future earnings, and is a forward-looking indicator. It allows investors to compare current to future earnings, and provides a good picture of what kind of earnings a company will likely report in the future, without any adjustments or changes. But this method can be flawed, as companies can be fairly conservative or generous with their estimates.
Forward P/E ratios may be flawed because of how conservative or generous companies may be with their estimates.
Price-to-Earnings Ratio and Real Estate
Determining the value of real estate investments depends on the type of investment in question. When it comes to valuing physical property, people tend to do so with appraisals, which measure the worth of a property and the land on which it sits. This is done by measuring a number of criteria including comparable homes and available amenities that are nearby.
But real estate companies can be evaluated by using the P/E ratio, just like companies in any other industry. Although the real estate sector is not universally defined, it generally includes real estate income trusts (REITS), property managers, and property developers. It is common for established real estate companies to trade at 35x to 45x forward earnings, due in large part to the fact that REITs are evaluated with different metrics compared to other types of companies such as funds from operations.
One important consideration when looking at a real estate company's P/E is depreciation, especially REITs. This is the amount by which a property's value decreases as it gets older. Because companies are permitted to allow for a certain amount of property depreciation over time and write these amounts off, which can skew the earnings figures.
Different Price-to-Earnings Models
There are a few different places you can turn to in order to get some average P/E ratios already calculated for the real estate—and other—industries. Here are two.
NYU Stern School
NYU's Stern School publishes P/E data for different industries and breaks real estate into four categories and lists their current P/E as of January 2022 as follows:
- REITs: 118.59
- Real estate development: 270.18
- General and diversified real estate: 34.41
- Real estate operations and services: 91.59
The data combines all REITs under one umbrella—a total of 238 firms. The school's most current data available, as noted above, was published as of January 2022. Real estate developers forward P/E is 711.91. General and diversified real estate companies forward P/E is 49.77. Firms engaged in real estate services and operations exhibit trailing P/E of 35.27 and forward P/E of 19.86.
Finviz.com
The stock screener tool on Finviz.com divides real estate companies into somewhat different industry categories. Median forward P/E among real estate developers is 12.89 as of August 2022. Forward P/E for office/property managers is 49.26.
For REITs as a whole, median P/E is 30.88. Subsets within the REITs category include retail, residential, office, industrial, hotel & motel, healthcare, and diversified. Industry-specific median P/E ratios within the REIT space range from 7.6 to 80.28.
