Friday, February 17, 2006

The Beauty of Back-of-the-Envelop Calculations
I have been calculating potential IPOListing prices/valuations for public non-traded REITs for sometime. I use a simple FFO multiple to determine a possible stock price. (FFO is Funds From Operations and for REITs is the equivalent of Earnings Per Share. So, an FFO multiple works similar to a P/E ratio for stocks.) I use a multiple of 8X to 12X, which is the historical range, although the current multiple is close to 14X.

Non-traded REIT sponsors do not like this calculation and avoid it as much as possible because most valuations come in below the non-traded REITs initial offering price. For the first time that I have seen a non-traded REIT has put this valuation method in print. The rational is the FFO valuation is too low and investors need to vote to liquidate the REIT’s portfolio rather than pursue a public stock listing through an IPO. You don’t say.

Putting the FFO metric to work on other REITs will likely result in similar below par valuations.

Here is an example. An initial $10 offering price gives an FFO of $.70 per share. Calculating times the historical range and current high give the following:

$.70 X 8 = $5.60 per share

$.70 X 12 = $8.40 per share

$.70 X 14 = $9.80 per share

While not exact, this back of the envelop calculation shows why the non-traded REIT sponsors are so anti-FFO.


Anonymous said...

How can this be a valuable measure given the fact that many of these Non-Traded REITS had very positive FFO multiples weeks before slashing their dividends or shutting down their offerings altogether? FFO multiples can easily be manipulated due to GAAP Accounting Standards. Dividends are not "secure" just because of a positive FFO multiple. There is "phantom" income that can be booked by using Long Term Leases, and "Cash Received" seems to be a much better indicator. Also, smaller REITS are at much more of a disadvantage in the early years given the huge start up costs associated to get them up and running. Someone needs to try to understand what is "behind" these numbers, because they are misleading and no better of an indicator of solid long term performance tha a P/E multiple is for equities. Also, what happens if a REIT negotiates a purchase price with a seller of less than appraised value?

Rational Realist said...

Thanks for the comment. This an old post and I am not sure what the current FFO multiples would indicate. I am not aware of any non-traded REITs that had very positive FFOs and then slashed dividends. I am aware of non-traded REITs that subsidized dividends from offering proceeds or borrowings and then cut dividends. Agree about the accounting slight of hand regarding leases, which is why I also look at operating cash flow and look further if it deviates too much from FFO. Small REITs are at a disadvantage to the bigger marketing machines. The FFO multiples don't consider growth, which like a P/E would allow for a higher multiple. Most non-traded REITs that I have seen have not had significant growth in FFO, but this would be important to track.