How to value a REIT
REIT valuation is a very important task when you want to invest in REITs. Why? Because your objective should be to accumulate shares of good REITs at a good value. But what is a good value?
Usually, there are two approaches to evaluate a REIT:
- absolute valuation: a fair value of a REIT, called Intrinsic Value (IV), is determined using methods like the Dividend Discount Model. Based on a projection of how much dividends a REIT will pay in the future, the IV is computed. If the trading price is below IV, then you can buy
- relative valuation: it is based on the Price/NAV (or Price-to-book ratio). If this value is below 1, then you can buy.
Which method should you use? Both have their pitfalls. The absolute valuation method may give you some unrealistic values because it is based on the historical dividend growth for the REIT and this can be inconsistent. On the other hand, if you follow the relative valuation method you may end up never buying a good REIT because some of them rarely trade at a P/NAV below 1.
If you are interested in this topic, and you want to learn a more robust way to value a REIT, watch the video below.