Are REITs Really a Bargain?

On Monday, the Fox Street Journal ran a story, saying that REITs were a "bargain."

Some analysts and investors believe that the heavy selling was too extreme and that some REITs - particularly those in the office and retail sectors - could stage a comeback. Indeed, just as the residential housing slump has produced some steals for home buyers, the REIT sell-off may similarly yield some good deals for stock-market investors. [Emphasis added.]

Similar articles were written in 2000 and 2001 about Cisco (CSCO), as the networking giant fell from $80 to $55-$60. The fawning press, and clueless analysts wrote that the all-mighty Cisco was also a "bargain" because it had fallen 25%.

Eventually Cisco fell to $8.

Other big cap tech stocks such as Microsoft (MFST), Intel (INTC), Applied Materials (AMAT), Oracle (ORCL), Sun (SUNW), also experienced precipitous declines.

And, at the time, you had clueless analysts and journalists, making specious arguments why the stocks were bargains even though they traded at ridiculous multiples on any basis other than recent history. We know how the Bubble played out.

There are many reasons why investors have seemingly turned their backs on REITs, which are publicly traded real-estate companies that distribute at least 90% of their taxable earnings in dividends. Many worry that rising borrowing costs could slow the pace of REIT property acquisitions. Others simply think the trend of the past few years, when annual returns for REITs averaged 20%, is unsustainable.

According to Stifel Nicolaus analyst David Fick, more than $3 billion has flowed out of U.S. real-estate mutual funds since May 1, representing one of the strongest outflows from dedicated mutual funds in the sector's history. "Many of the investors [dumping] REITs are nontraditional real-estate investors who jumped into the market in recent years chasing higher returns but aren't long-term holders," Mr. Fick says.

Perhaps there is another reason for the selling, of which seems not to have occurred to the author of the article.

But this wholesale dumping is the main reason certain blue-chip REITs offer the best bargains now. [Emphasis added.] During the REIT heyday, these stocks were more widely owned by many nondedicated REIT investors. But just as these premier REITs benefited the most during the frenzy over REIT consolidation and buyouts by private-equity firms, they now are being sold off the hardest as investor sentiment has soured.

Bargains based on what? "Good management?" What does "good management" have to do with bargains? Cisco had good management at $60. Was it a bargain then? What about "rising borrowing costs?" Or "past returns?" Or "money outflows?" What do any of these have to do with whether or not an asset is a bargain?

The author of the article said that REITs may now offer a "bargain for stock investors." But, as we have shown, REITs trade at a premium to stocks of 40% based on funds from operations, and 80% based on earnings estimates. Compared to history, the dividend yield is about half of what REITs have paid in the past.

This is a bargain?

Disclosure: I remain short REITs via put positions on the REIT ETF (IYR). I intend to add to positions on any rally.

SA Editor: See also full listing of Real Estate [REIT] ETFs.

IYR 1-yr chart:

Comments

[Yaser Anwar_:]

IMO- the way to trade REITS is to match their yields with those on the risk-free securities. When REITS are yielding at least 4% higher than risk-free rate, its'a good time to get in. Back in 2001, the REITS yielded close to 6-8% and risk-free rate was 1-2%. Now the gap is a lot smaller and in some cases non-existent.

2007 Jul 20 05:33 AM

[kurt walter:]

REITS had a great 6-year run. I would not touch them until they have been beaten down for quite a while. What is the rush? The cycle isn't close to the bottom, yet.

2007 Jul 20 10:28 AM

[kennison:]

I have an MBA in finance and urban land economics. I have traded office, retail, multifamily, industrial, and mixed use properties. These properties today are trading at cap rates that are less than 10 year treasury yeilds and are heavily leveraged with mezzanine debt. Blackstone purchased EOP at an 8.4 PEG. Many of these REITS are trading at PEGs exceeding 4. These values are bloated beyond any economic justification. The correction in the housing market has not bottomed...it hasn't even started. If the mortgage originators, appraisers, loan brokers were making goofy loans to joe homebuyer...I can guarrantee you they were making goofy loans to joe developer. The REITS, the investment real estate market, and the general real estate complex is overvalued by a multiple of at least 2.

2007 Jul 20 11:51 AM

[justin.emalius:]

If vacancy signs started going up at malls and office buildings and rents started coming down, I might buy the thesis that REITS were going lower. So far, that hasn't happened - at least not here in the DC metro area - so why should I look at this as anything but a buying opportunity?

2007 Jul 20 08:54 PM

[Long-Short Guy:]

Related:
<blockquote>
<b>The problem with REITs? They're pricey</b>

...REIT yields have fallen in the past five years, even though interest rates and dividends in the broader market have risen. In June 2002, the average REIT offered a dividend yield of 6.5%, vs. 4.8% for a 10-year Treasury note.

But soaring share prices have pushed REIT yields down. REITs now yield less than the 10-year T-note. Should long-term interest rates rise — which could happen if the economy strengthens further — REITs will face tough competition from bonds...
</blockquote>

Source:
www.usatoday.com/money...

2007 Jul 22 05:01 PM

[PJ M:]

Yields down?, the yield on RQI is close to 10%.

2007 Jul 30 04:03 PM