CIOs and REITs: What Were They Thinking?

Last week, I read a report by Citigroup on intended three-year asset allocations of 50 CIOs who control $1 trillion in assets. The survey was the subject of an article in The New York Times.

During the last two weeks of July and the first week of August, amid a widespread market meltdown, Citigroup surveyed close to 50 pension managers from the United States and Europe who collectively manage over $1 trillion in assets.

The survey showed they would, on average, raise their allocation in alternative investments to nearly 20 percent by 2010 from 14 percent today. In all, that would mean another $1.2 trillion flowing into alternatives over the next two years.

That money is coming out of traditional stock and bond investments.

So, I went back and looked at the price indices for both the S&P 500 (SPY), and the Dow Jones U.S. Real Estate Index (IYR). On December 31, 1999, the S&P 500 closed at 1469.25. On Wednesday, it was at 1564.05. The Dow Jones US Real Estate index was at 125.77 on the last day of the 1990s. On Wednesday, it closed at 313.68. Thus, in the past seven and three-quarters years, stocks have risen 6.5% in total whereas REITs have risen 149.4%.

Not only that, but at the start of the decade, REITs were cheap, trading at ~7x funds from operations (FFO), whereas stocks were nose-bleed expensive, trading at ~30x trailing earnings. On Thursday, REITs were 14x FFO - sky-high expensive - and stocks were 18x trailing earnings - not cheap but not expensive either. (At least on current profit margins.) On FFO, REITs are trading at a 40% premium to equities, and nearly 100% on forward estimates.

All this while at least one category of commercial real estate is at the highest vacancy rates in 5.5 years.

U.S. strip-mall vacancies only inched up in the third quarter, but still hit a 5½-year high, spurring concerns about cutbacks in consumer spending. Rentals of retail space in weak housing markets are getting hit disproportionately hard, as consumers rein in their purchases.

The retail sector has been a pillar of the commercial real-estate industry -- and the overall economy -- for the last seven years, riding out economic downturns on steady consumer spending strengthened by soaring housing prices and easy credit. The end of the housing boom and the current credit crunch have analysts and investors watching for signs of weakness. ...

The strip-mall vacancy rate rose to 7.4% in the third quarter, from 7.3% in the second quarter and 7% in the year-earlier period. Along with the first quarter of 2002, when the vacancy rate was also 7.4%, that level was the highest in 11 years, according to a survey of 76 U.S. retail markets by Reis.

And CIOs want to put more money into commercial real estate?Is reversion to the mean, and the value effect dead?

It would be interesting to know what this survey looked like at the end of 1999, when investors were tossing money at the technology venture capitalists like it was going out of style.

(Paradoxically, a former intern of mine went to work in the energy department of a private equity firm in Dallas in the late 1990s. He called me shortly after he arrived, and told me they could not raise money for their fund. Nobody wanted to invest in energy.)

This is the reason that pension recipients are going to be sorely disappointed in their CIOs a decade from now.

Disclosure: I am short REITs.

Comments

[ikkyu]

Increase by 2010.... did you think they were going to just buy tommorow? Allocate and buy may be two different things. If i had a pension i would be happy about this.