© Elliott R. Morss All Rights Reserved
For the last six months, I have recommended investments in US real estate and in commodities. I still believe both remain attractive investment vehicles. In this, the first of a two-part series on investments, US real estate is examined. The second piece will focus on commodities and ask whether the commodity-rich countries of Sub Saharan Africa deserve a closer look.
The Real Estate Cycle
The reasoning for real estate investments is that real estate runs in cycles that take years to complete. That means that once things start going in a certain direction, momentum will build and the direction (up or down) will continue for a number of years. The blue line in Figure 1 provides data on residential prices adjusted for inflation from 1890 to 2013. Note just how dramatic the upturn in prices was before the global collapse. The US real estate market bottomed out a couple of years back, and every indication is that it is now just starting on the upside of the cycle. This upside momentum should last for some time as supply works to catch up to demand. The red line provides the straight line regression estimate of prices over the 1890-2013 period. Note that real estate prices remain below the long-run average.
Figure 1. - US Residential Prices Adjusted for Inflation
Source: Robert J. Shiller, Irrational Exuberance, 2nd. Edition,
Princeton University Press, 2009 with Shiller updates
But how long are the ups and downs of real estate cycles likely to last? To address this question, I went back to the Shiller data and defined a "cycle" as a change in prices that lasted for two years or more. The results are presented in Table 1 for upturns and downturns lasting two years or more.
Table 1. - US Residential Real Estate Prices
Up or Downturns Lasting Two Years or More
Source: Robert J. Shiller, op. cit.
Note that all upturns since 1969 (highlighted in bold) have lasted 3 or more years. And since hitting a low in the first quarter of 2012, residential prices have risen 8.4%.
Employment offers another example that real estate is far from peaking. The Labor Department repost that employment in residential building is down from 1,037,000 in August 2006 to 590,000 in May of this year up just a bit from the 555,000 bottom hit in January 2011.
Real estate investments have cooled a bit over the last 4 weeks. But the real estate upturn has just started. Table 2 offers a number of investment opportunities worth considering.
Table 2. - Possible Real Estate Investment Vehicles
KBW Premium Yield Equity REIT Portfolio (KBWY)
Market Vector Mortgage REIT Income ETF (MORT)
FTSE NAREIT Mortgage REITs Index Fund (REM)
IQ US Real Estate Small Cap ETF (ROOF)
Brookfield Asset Management (BAM)
Fidelity Real Estate Income Fund (FRIFX)
KBWY is an ETF based on the KBW REIT Index. The Index was created and managed by Keefe, Bruyette & Woods, Inc. It is calculated using a dividend yield weighted methodology that seeks to reflect the performance of approximately 24 to 40 small- and mid-cap equity REITs in the United States. The ETF has been a great performer over the last year, but like all US real estate investments, it has sold off some the last 4 weeks. It has a very high P/E ratio, but does have an attractive dividend yield.
MORT is based on the MVMORTTR index intended to track the overall performance of publicly traded mortgage REITs. Its performance over the last year has not been as stellar as others, and it did sell off quite sharply in the last 4 weeks. However, it has a low P/E ratio and a high dividend yield.
Both MORT and REM have sold off over the past month on increased talk the Federal Reserve is close to winding down its asset-buying activities. However, the Fed and other parts of the Federal Government will be very careful to avoid anything that will slow the housing recovery. REM has a low P/E ratio and an even higher yield than MORT.
ROOF tracks the price and yield performance of the IQ US Real Estate Small Cap Index. Emphasis in the index is on the smaller U.S. real estate companies. It jumped smartly over the last year with very little sell-off over the last few weeks. It has a pretty high P/E ratio and a reasonable dividend yield.
BAM is a huge Canadian company with investments in real estate and energy primarily in Canada, the US, and Brazil. Its growth appears modest relative to the other vehicles listed in Table 2. But having investments in two sectors, both of which are growing rapidly, reduces its risk. FRIFX is a leading real estate mutual fund focusing on high yield.
I believe all Table 2 investments will do well over the next few years.