There are a lot of different things you should consider before jumping in and putting your money into a specific investment. Doing a value analysis of the potential investment can help you determine whether it is a good choice or not. This process is called valuation and helps investors determine the current and projected value of an asset. Performing an investment value analysis means that you will need to know some of the business metrics as well as information about the management of the business. This goes for businesses in any type of industry, including real estate. This article examines price-to-earnings (P/E) ratios and how they are measured in the real estate industry.
Key points to remember
- Price-to-earnings ratios can help investors decide which 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, as REITs are valued with different metrics than other companies.
- Investors should remember that asset depreciation can skew a REIT’s earnings numbers.
What is the price/earnings ratio?
The price/earnings ratio (P/E) is an important part of fundamental analysis. It is a commonly cited valuation measure 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 growth rate and macroeconomic conditions, and valuations are different across industries. The earnings portion of the P/E ratio can refer to current or forward estimated earnings, and expected earnings are generally more influential for valuation purposes.
The P/E ratio tends to be a preferred method of analysis because it gives earnings a relative price. This helps determine when there are discounts to be had or if stock prices are getting too unaffordable.
The latest P/E is a valuation based on the last 12 months of actual earnings. To calculate it, we take the current share price and divide it by the EPS of the last 12 months. This turnover can be found on both the annual report and the income statement. Some investors and analysts prefer to use this number because it is more accurate, as it uses actual numbers. But keep in mind that past performance is not necessarily indicative of the future.
Rather than using actual numbers from the past, the forecast PER uses indications of future earnings and is a forward-looking indicator. It allows investors to compare current earnings to future earnings and gives a good idea of the type of earnings a company is likely to report in the future, without any adjustments or changes. But this method can be flawed, as companies can be quite conservative or generous in their estimates.
Future P/E ratios can be off because of how conservative or generous companies are with their estimates.
Price/earnings ratio and real estate
Determining the value of real estate investments depends on the type of investment in question. When it comes to appraising a physical property, people tend to do so with appraisals, which measure the value of a property and the land it sits on. This is done by measuring a number of criteria, including comparable homes and amenities available nearby.
But real estate companies can be valued using the P/E ratio, just like companies in any other industry. Although the real estate industry is not defined universally, 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, largely because REITs are valued with different metrics than other types of companies such as funds from operations.
An important consideration when looking at the P/E of a real estate company is depreciation, especially REITs. It is the amount by which the value of a property decreases as it ages. Because companies are allowed to allow a certain amount of asset depreciation over time and to write off those amounts, which can skew profit numbers.
Different P/E Patterns
There are several places you can turn to for pre-calculated average P/E ratios for real estate and other sectors. Here are two.
NYU Stern School
NYU’s Stern School publishes P/E data for different industries and divides 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 groups all REITs under one umbrella, a total of 238 companies. The most recent data available from the school, as noted above, was released in January 2022. The forward P/E for real estate developers is 711.91. The forward P/E for general and diversified real estate companies is 49.77. Companies engaged in real estate services and operations show a back P/E of 35.27 and a forward P/E of 19.86.
The stock screening tool on Finviz.com divides real estate companies into somewhat different industry categories. The median forward P/E among property developers is 12.89 in August 2022. The forward P/E for office/property managers is 49.26.
For REITs as a whole, the median P/E is 30.88. Subsets of the REIT category include retail, residential, office, industrial, hotel and motel, healthcare, and diversification. Industry-specific median P/E ratios in the REIT space range from 7.6 to 80.28.