A colleague of mine recently brought an interesting phenomenon to my attention. REITs and one particular REIT – Simon Property Group (NYSE: SPG) – have had quite the run in the last few months. The above chart runs from March until today – June 22, 2009. It’s clear to see that REITs as an asset class (using VNQ as a proxy) have rallied in excess of the broad market. Simon Property Group – a REIT specializing in malls and outlet centers – has rallied even in excess of the REIT class in general (almost 75%)! With the S&P 500 (and likely the broader market in general) now showing weakness, could SPG be vulnerable to a precipitous fall?
It would seem that the increased interest in the REIT asset class and, in particular, premium names such as SPG has been driven mostly by institutional reallocations to real estate at the beginning of the year. This has allowed many REITs to recapitalize and assuage investor fears of potential liquidity issues within the sector. With beginning of the year reallocations set and the market seemingly poised to correct, demand for REIT stocks could face pressure.
Simon Property Group Valuation
The traditional metric for REIT stocks is Price to Funds from Operations (FFO) which is a simple adjustment to net income to better approximate true operational profits by adding back depreciation and amortization expenses. We find that SPG is trading slightly above peers in this category. Further, its trading multiple has increased significantly since the end of 2008.
On a price-to-EBITDA basis, SPG is also trading roughly in line with peers, but still below levels at the end of 2008 despite the overall economic outlook firming up in the last few months.
On a price to square foot basis, the market is once again valuing SPG at a premium to other retail oriented REITs. Seems to me that we have a trend here.
Could SPG be in for a larger correction?
Last but not least, let’s take a look at how SPG compares to its peers. For one thing, SPG is larger than most of its competitors. Second, it’s more conservatively levered than most of its peers. And, finally, it squeezes more earnings per square foot out of its properties than most of its competitors. It would seem that Simon is at least somewhat deserving of its current above average valuation, but it’s hard to say the extent to which this is reasonable. It would seem that at least in the near term, SPG is a good candidate for a short term correction.
Full disclosure: Author has no positions in the stocks mentioned at the time of writing.
