Breaking Down REIT Prices
As with all financial assets, real estate investment trust (REIT) valuations should equal the discounted present value of expected future cash flows. REIT prices thus reflect the growth potential of cash flow (rents, expenses) and/or the time variation in expected returns (interest rates and risk premium, which is the discount rate).
Given currently low yields on REITs, an important question for investors is: Do high prices today relative to dividends (low dividend yields) mean that there are optimistic expectations of future dividends? Or, do high prices relative to today’s dividends imply low future returns?
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