When Things Are Going Badly at Home, People Linger at the Office by Michael Santoli
Summary: The much talked-about cooling of the housing market has done damage to homebuilder stocks and related industries. But commercial real-estate, represented by the REIT sector, continues to forge ahead. The DJ Composite REIT index is up nearly 20% YTD, humbling bears including Barron's who warned a year ago that REITs looked toppy. Fresh money keeps pouring in to the sector. Possible reasons for the sector's strength: 1) A quest for yield vehicles that can increase dividends over time. 2) Money looking for somewhere to go post stock-market bubble burst. 3) Funds such as pension plans looking for non-correlated asset classes. In a survey of 300 current real-estate investors, 66% said they plan to increase their allocation to the sector. Have we reached the top? 1) Current appreciation is at levels that match 1987 and 1997 peaks, which were followed by steep corrections. 2) Yield relative to T-bonds is also comparable to previous tops. 3) But leverage now is far lower than in earlier peaks. The Trader's conclusion: "Real estate is a slow-moving market. REIT stocks have remained in firm uptrends that have proven remarkably resilient. And we've been wrong on the group before. But the stocks are getting far too widely loved and too broadly owned for the risk/reward trade to stay favorable."
Quick comment: As the author notes, ever-higher demand pushes prices up, and cuts into future returns; it's a question of when the sector reaches saturation. In a subsequent piece, the author notes that those wishing to play strong commercial real-estate without competing for the buildings themselves can use vehicles such as Interface Inc. (IFSIA), which makes modular carpeting for office buildings. Market Participant notes that iShares Cohen & Steers Realty Majors ETF (NYSEARCA:ICF) currently yields 3.14%, which is substantially less than the current T-bill rate of 5%. To justify such valuation, REITs must register FFO growth in the 10% range, far higher than their historical capabilities. In a recent Barron's interview, Marty Cohen of Cohen & Steers said that despite their run-up, domestic REITs still look strong, while admitting that international REITs, such as Europe and Hong Kong, look stronger yet. In a subsequent post, David Jackson points out that Mr. Cohen failed to come up with even one domestic REIT recommendation. But it's been a painful ride for the shorts (see chart). Andrew Mickey selects 5 REITs he feels should outperform the sector. Marc Gerstein looks to REITs that rent to retailers as a play on the retail sector that should get a boost from current interest-rate leveling.