Exchange-Traded Funds (ETFs) are a popular way to invest in real estate through REITs (Real Estate Investment Trusts). By offering a diversified portfolio of REITs, ETFs allow investors to gain exposure to the real estate market without having to pick individual REITs. However, understanding whether an ETF’s underlying assets are fairly priced can be a challenge. One effective method is analyzing the ETF’s Funds From Operations (FFO) multiples.

In this guide, we’ll explain what FFO multiples are, how they’re calculated for ETFs, and how you can use them to make informed investment decisions.

What Are FFO Multiples?

FFO multiples are tools investors use to evaluate the pricing of REITs and REIT ETFs. Funds From Operations (FFO) is a measure of a REIT’s cash-generating ability. Unlike traditional earnings, which include non-cash expenses like depreciation, FFO adjusts for these to give a clearer picture of the real cash flow. With that in mind, an FFO multiple tells you how many times the market is pricing a REIT’s or ETF’s FFO. Here’s the formula:

FFO Multiple = Share Price / FFO per Share

For ETFs, this calculation involves the weighted average FFO of the REITs in the ETF’s portfolio. For a more thorough explanation about using FFO Multiples to price REITs, check out our article: Pricing REITs: FFO Multiple.

How Do We Calculate FFO Multiples for ETFs?

For REIT ETFs, we calculate FFO multiple using analyst forecasts for the FFO in the current and next years. Here’s how it works:

1. Obtain FFO Forecasts: Analysts project FFO for the current year and the next year for most of the REITs in the ETF’s portfolio. Note that we publish the percentage of holdings used for the calculations for each ETF.
2. Calculate the Multiple: Divide the REIT’s market price by the FFO per share.
3. Apply Weighting: Each REIT’s FFO Multiple is weighted according to its holding percentage in the ETF.
4. Combine FFO Figures: Add up the weighted FFO Multiples for all REITs in the portfolio to obtain the weighted average FFO Multiple of the ETF. We receive two figures, for this year and for next year.

By using this method, investors get a single FFO multiple that reflects the ETF’s valuation based on its portfolio composition. You can find the weighted average FFO Multiple of many real estate ETFs on our website, both on the main ETFs page and on individual ETFs pages.

What Do FFO Multiples Tell Us?

Comparing ETFs

FFO multiples allow you to compare the pricing of different REIT ETFs. For example:

• Higher Multiple: Indicates the ETF is priced higher relative to its FFO. This could mean investors expect strong growth, higher-quality assets, or lower risk.
• Lower Multiple: Suggests the ETF is cheaper relative to its FFO. This might signal undervaluation but could also indicate higher risk or weaker growth prospects.

Sector Composition Matters

The composition of the ETF’s portfolio plays a significant role in its FFO multiple. REITs in certain sectors, like data centers or industrial properties, have shown higher FFO multiples in recent years due to increasing demand and strong growth potential. On the other hand, sectors like retail or office properties might trade at lower multiples due to higher risks or slower growth.

For example, an ETF with a significant allocation to data center REITs will likely have a higher FFO multiple than one focused on retail REITs. On each ETF’s individual page, we show the sector weights, and for U.S. REIT ETFs, we calculate the FFO multiples for the holdings in each sector. This allows investors to see how different sectors affect the ETF’s overall average, helping them avoid comparing apples to oranges and understand how the pricing of each sector affects the average multiple of the ETF.

Historical Averages

Comparing the ETF’s current FFO multiple to its historical averages provides insight into whether it’s fairly priced. However, the historical view should be adjusted to account for the prevailing interest rate environment, as changes in interest rates can significantly impact multiples. If the current multiple is significantly higher than the adjusted historical average, it might indicate overvaluation. Conversely, a lower multiple could suggest a buying opportunity—but only if other factors support it.

Using FFO Multiples to Analyze REIT ETFs

Here are some practical steps to analyze ETFs using FFO multiples:

1. Compare to Peers: Look at the FFO multiples of similar ETFs, or compare the FFO multiples of ETFs that focuse on different sectors, to assess the difference in pricing.
2. Assess Sector Composition: Check which sectors dominate the ETF’s portfolio. Are these high-growth sectors or sectors facing challenges?
3. Review Historical Multiples: See how the ETF’s current multiple compares to its past averages. Significant deviations warrant further investigation.
4. Understand Growth Potential: Consider whether the ETF’s underlying REITs have solid growth strategies, such as expanding into new markets or acquiring high-quality properties.

Why Weighted Average FFO Multiples Matter

On REITvesting, we present the weighted average FFO multiples of various ETFs based on FFO forecasts for the current and next years. This approach gives you a comprehensive view of an ETF’s valuation by:

• Reflecting the combined pricing of the ETF’s underlying REITs.
• Accounting for the different weightings of REITs in the portfolio.
• Offering a forward-looking perspective by using forecasted FFO.

By understanding these multiples, you can better assess whether an ETF aligns with your investment goals and risk tolerance.

Key Takeaways

• FFO Multiples are essential tools for analyzing REIT ETFs, providing insight into their valuation.
• Sector Composition heavily influences an ETF’s multiple, so always consider the types of REITs it holds.
• Interest Rates and Growth Prospects are critical factors that can drive multiples higher or lower.
• Historical Comparisons and peer analysis help determine whether an ETF is fairly priced.
• Weighted Average FFO Multiples presented on REITvesting allow you to assess real estate ETF pricing. 

Disclaimer: The information provided in this post is for informational purposes only and reflects my personal opinions. It should not be considered as professional financial, legal, or investment advice. Please consult with a professional before making any investment decisions. I am not responsible for any actions taken based on this information. For more details, please refer to our full disclaimer.