Are REITs Getting Ahead of Themselves?

Equity REITs in the US have been rising since the March lows like most categories, but have surged in the past few days, as the larger US and international stock markets have moderated their rise, including some recent down days.

REIT investors may be relying on the arguments that the recession is ending more than the issues of yet to fully develop commercial real estate credit problems, including problems they may have in refinancing soon to mature debt.

They certainly have attractive yields versus Treasuries and versus stocks generally, based on trailing 12 months. Will they be able to keep it up? If they are not ahead of themselves, and if they can maintain distributions, their yields look pretty good. On the other hand, if a new wave of financing problems lie ahead, these could be rather risky assets.

We are not presenting a recommendation for or against REITs at this time, but feel they have been off the radar screen for many investors for some time since their crash in 2007. Because they are showing new price action life, we think some spotlight on the category is appropriate.

It’s interesting to note that over a five year period, the MSCI REIT index is slightly ahead of the S&P 500 on a price basis, but slightly behind aggregate US bonds.

The correlation between REITs, the S&P 500, aggregate bonds and money market funds (as measured through Vanguard mutual funds) shows REITs over five years as having approximately 0.80 correlation with the S&P 500. Like the S&P 500, REITs have a low correlation with bonds or money market funds.

Here are charts of the percentage performance of the S&P 500 index (in red) versus the MSCI US Equity REIT index (in black) for 1 year, 6 months and 1 month. In the last few days, REITs have shown strength, while the S&P index has shown weakness.

Disclosure: We own VTI, EFA, and EEM in some accounts.

Comments

[Mad Hedge F...:]

Ahead by miles. Chicago magnate Sam Zell thinks the big foreclosures won’t hit commercial real estate until the institutional holders run out of money in 2-3 years. From 2000 to 2007, half of the commercial properties in the US were sold and releveraged, and even the weaker holders have enough cash flow and reserves to last until then. Having peaked at a higher top, single family homes are now crawling off a much lower bottom, giving a crucial boost to an economy based on consumer spending. I’d call this a future green shoot, if I didn’t know that the grizzled property pro was talking his own book. After completing a brilliant sale of a huge portfolio of properties to the Black Rock Group at the absolute peak of the market, Sam is now suffering from buyer’s remorse with a turbocharger, having rolled the money into the bed ridden and nearly comatose Chicago Tribune/Cubs combo. Sam’s favorite overseas foray is Brazil, where a large, growing, educated population backed by rich natural resources, falling interest rates, and a strong currency provide a great backdrop for property investment. China looks good too, but you have to speak Mandarin.

Aug 06 03:49 PM

[Jade Queen:]

I second the positive comments about Brazil. There are parts of Brazil with enlightened local governments, and there are companies which are models of transparency.

These places and corporations are held up as world models for class mobility, and I would say they are good bets. They have been much visited and examined by the world community. From the political right and the political left, they have been pretty well crawled over, and you can watch YouTubes about it.

Smart Brazilians have figured out about bad loan terms from western entities. This bodes well for truly win-win deals with life-partner investment time spans rather than short-term exploitation schemes.

That there are opportunities in China may be true as well, but it is much more difficult to figure this out about China, probably even if you speak Mandarin.

I own Suntech. It has a good reputation for its products, it has a tech-intensive moat against upstarts, it has a diverse product line-up, it is probably too big to fail in China, and because the advantage of solar for advantaged individuals and entities seems so great to me (flight to quality: with panels and a rolling hybrid generator, one can always have power).

I can't know enough about property in China to feel safe with it. If China gears up an installed base of renewable energy, I'll be more interested in its property potential, but not until more movement in that direction.

Aug 06 05:09 PM

[Lewis Whoke...:]

How does this apply to Agency REITs which invest only in government guaranteed Mortgage Backed Securities?

I'm referring to REITs like NLY, HTS, CMO, and AGNC.

The author just lumps all REITs together.

Aug 07 07:23 AM

[JSRR1950:]

If you want to play Brazil for those reasons, check out Brookfield Asset BAM.


On Aug 06 03:49 PM Mad Hedge Fund Trader wrote:

> Ahead by miles. Chicago magnate Sam Zell thinks the big foreclosures
> won’t hit commercial real estate until the institutional holders
> run out of money in 2-3 years. From 2000 to 2007, half of the commercial
> properties in the US were sold and releveraged, and even the weaker
> holders have enough cash flow and reserves to last until then. Having
> peaked at a higher top, single family homes are now crawling off
> a much lower bottom, giving a crucial boost to an economy based on
> consumer spending. I’d call this a future green shoot, if I didn’t
> know that the grizzled property pro was talking his own book. After
> completing a brilliant sale of a huge portfolio of properties to
> the Black Rock Group at the absolute peak of the market, Sam is now
> suffering from buyer’s remorse with a turbocharger, having rolled
> the money into the bed ridden and nearly comatose Chicago Tribune/Cubs
> combo. Sam’s favorite overseas foray is Brazil, where a large, growing,
> educated population backed by rich natural resources, falling interest
> rates, and a strong currency provide a great backdrop for property
> investment. China looks good too, but you have to speak Mandarin.
>

Aug 07 11:04 AM

[Kinabalu:]

There's no question that credit problems lurk for commercial REITs. However their stock prices have fallen so far in anticipation of those problems that this tiny recovery doesn't really add any risk. For example, NRF, a commercial REIT with good liquidity, i.e. a likely survivor, has risen 40% from last November. But it's still trading at only one quarter of where it was in 2007.

Aug 07 06:55 PM

[Kinabalu:]

Lewis

See the first word in the article - Equity. The REITs you are referring to are playing on a completely different field


On Aug 07 07:23 AM Lewis Whokeyser wrote:

> How does this apply to Agency REITs which invest only in government
> guaranteed Mortgage Backed Securities?
>
> I'm referring to REITs like NLY, HTS, CMO, and AGNC.
>
> The author just lumps all REITs together.

Aug 07 06:58 PM