Peter LoBrutto's  Instablog

The current conventional wisdom says that even after stellar returns of over 40% in 2010, residential REITs stand to continue to benefit from the ongoing U.S. residential real estate bust. Foreclosures remain high, mortgage rules are stricter, there is a lack of new construction, and homeownership is on the decline. These factors are leading to rising occupancy rates and higher rental rates.

But are all of these positives already (over)priced in the market? If we use as a proxy the iShares FTSE NAREIT Residential Plus Capped Index ETF (REZ), which tracks 36 different REITs in the apartment and senior living sectors, we see that the current yield is approximately 3.48%. Let's think about that for a moment:

• Who in their right mind would invest in real estate at a 3.48% cap rate?
• That compares to the current U.S. 10-year Treasury yield of 3.41%
• That's lower than the current dividend yields of the following Dow Jones Industrial Average stocks: AT&T, Verizon Communications, Merck, Pfizer, Kraft Foods, Johnson & Johnson, and Intel.
• That's derived from a set of illiquid assets strictly denominated in U.S. Dollars.

Does that sound like an undervalued investment to you? It doesn't to me. And besides, a variety of things could go wrong with the bullish thesis:

• Pressure on rents due to stagnant or declining American worker wages,
• A decline is housing formations due to the poor economy,
• A decline in immigration,
• An increase in the renting of single family homes as opposed to apartments, 
• Or a decline in the U.S. Dollar.

All in all, it doesn't appear that U.S. residential REIT investors are being adequately compensated for the risks that they are currently taking.