From Seeking Alpha Source
The S&P and REITs calculate their earnings multiples of the index differently.
When we apply the same methodology to each index, REITs appear significantly cheaper.
The relative value of REITs compared to the S&P is being obfuscated by the unfavorable method REITs employ in calculating the index multiple.
Different indices use different methodologies to calculate earnings multiples. This can have profound implications on the perceived valuation of the underlying sectors of the economy. This article will examine the differing methodologies of index multiple calculation between REITs and the S&P. We believe the differing methodologies are making REITs and the S&P look like they trade at similar valuations, while REITs are actually significantly cheaper if we use the same methodology for each index. Let us begin with a look at the methodologies employed by the indices.
The 2 methods
SNL Financial (now run as S&P Global Market Intelligence) is the informational platform that most directly covers REITs. Bloomberg, FactSet, and others cover REITs, but not with the individual attention that SNL Financial provides. SNL covers REITs using REIT metrics like FFO and AFFO obtained through aggregating the estimates of sell-side analysts. This REIT specialty makes SNL the dominant reporter of P/FFO of the REIT index, which makes it their methodology that I will be comparing with the methodology of the S&P.
SNL shows the P/FFO of the REIT index at 20.99 as of July 17th 2019.