Are We Facing A REIT Bubble?
James Grant seems to think so as stated in a recent article in FORBES magazine. Grant points out that at the March, 2000 stock market peak the S&P 500 traded at 33 times earnings and could do no wrong. The Bloomberg Real Estate Investment Trust Index, on the other hand, traded at a multiple that was 40% of the S&P's and could do no right. But a funny thing happened on the way to tommorowland. REITs got hot, but the S&P didn't. By so vast a margin did the REITs subsequently excel that the blue chips would have to quadruple tomorrow simply to close the gap.
Income producing property can be a superb investment. So, too, can REITs, which pay out 90% of the income they earn from the assets in which they invest, buildings or mortgages or both - with the focus here being on buildings.
It almost goes without saying that no investment asset is either inherently good or inherently bad. Valuation is the all in all. At the low March, 2000 valuations REIT investors had that sleep-enhancing cushion known as a margin of safety. At the much, much higher prices now prevailing, they have no such protection, only the smug knowledge of past returns.
Just by going up, real estate has made believers of the former skeptics on America's investment-policy committees. What a difference seven years make. Now, ostensibly, no price is too high, because rents will go up forever and private equity investors will buy up any REIT not nailed down.
But hold on: As the return on buildings pushes lower, the cost of financing them edges higher. But not to worry, the bulls insist. Real estate isn't about the cash flow. It's about the price appreciation. An earlier generation of bulls once said the same thing about tech stocks.
So bottom line, what Grant is really saying is that realty trusts have done well - too well in fact for their own good. But yields are so-so, and in his view, the best course now is to short them.
* * * * *
Income producing property can be a superb investment. So, too, can REITs, which pay out 90% of the income they earn from the assets in which they invest, buildings or mortgages or both - with the focus here being on buildings.
It almost goes without saying that no investment asset is either inherently good or inherently bad. Valuation is the all in all. At the low March, 2000 valuations REIT investors had that sleep-enhancing cushion known as a margin of safety. At the much, much higher prices now prevailing, they have no such protection, only the smug knowledge of past returns.
Just by going up, real estate has made believers of the former skeptics on America's investment-policy committees. What a difference seven years make. Now, ostensibly, no price is too high, because rents will go up forever and private equity investors will buy up any REIT not nailed down.
But hold on: As the return on buildings pushes lower, the cost of financing them edges higher. But not to worry, the bulls insist. Real estate isn't about the cash flow. It's about the price appreciation. An earlier generation of bulls once said the same thing about tech stocks.
So bottom line, what Grant is really saying is that realty trusts have done well - too well in fact for their own good. But yields are so-so, and in his view, the best course now is to short them.
* * * * *
posted by Bob Moser at
7:31 PM
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