January 4, 2018 glacierinvest

Margins and multiples for a given sector tend to be quite cyclical. It’s no different for REITs. While margins may permanently expand as a portfolio gains scale, it will still be subject to the cyclical fluctuations in revenues and operating expenses.

We compared EBITDA margins to EV/EBITDA multiples[1] from last cycle’s peak to current levels for a universe of 137 US REITs to get a sense of profitability vs. value. Trailing four quarter EBITDA margins peaked at 56.4% last cycle and so far this cycle have peaked at 58.0% in 1Q17, a modest expansion of nearly 3%.  Since 1Q17, margins have contracted to 57%.

EV/EBITDA multiples on the other hand peaked at 15.6x last cycle and reached a peak of 17.4x in 2Q16 this cycle. Currently, the group trades at 16.9x multiple. So relative to last cycle, the most recent margins are 1% above last cycle’s peak while multiples are 8% above last cycle’s peak. Not a huge dislocation given REITs’ increased presence in indices and asset allocations across all investor types this cycle. As a result, it doesn’t appear there is a huge disconnect between profitability and value at this point.

However, it should be noted margins have been contracting for two consecutive quarters. Barring a turnaround in margins (or at least a leveling off), multiples would likely contract from here if historical trends have any sort of predictive power. On that note, it appears investors do a good job of anticipating REIT margin expansion but perhaps are caught more flat-footed when margins contract.


[1] While EBITDA multiples aren’t necessarily the go to metric for REIT valuations, they are probably subject to less error and manipulation than FFO and NAV and are probably among the best “least common denominators”.