REITs continue to rise; why is that ?

[lewman]

REITs like VNQ, EOP, EQR continue to defy gravity and some are making new highs, while stocks related to home building, mortgage, materials, etc are dropping like flies.

If I’m not mistaken, REITs hold physical real estate assets and if RE prices go down, the NAVs must go down to reflect this and so should the REITs’ prices. Any possible explanations for why it hasn’t happened ?

[barnaby33]

I’d really like to know this as well. I just sold the 3 REIT’s that I held, and all of them have gone up in the last 3 months.

Josh

[(former)FormerSanDiegan]

The simple answer is that when bond yields go down, the relative value of REIT dividends go up. So, REITS tend to move in opposite direction of bond rate or anticipation thereof.

Consider that REITS pay dividends in the 5-8+% range. The 10-year treasury has moved from well above 5% to < 4.8% today. So, the relative value of the REIT dividend stream has become more valuable. REITS may include apartments (rents have increased), commercial space, industrial space, some hold mortgages (yuck). The stock market has not assigned the same forward-looking pessimism to the commercial or apartment sectors that it has to the home builders.

[powayseller]

Just because a dividend increases, doesn’t mean your investment is any better. On the Prudent Investment thread, malfred wrote that he likes Southern Copper, bec. of its 9% dividend yield. History is full of companies which paid a high dividend despite their depreciating values; ponzi schemes also pay dividends; so a dividend doesn’t mean anything if my principal is eroding. Copper is in a huge bubble; I wouldn’t touch it with a 10foot pole.

Be careful of anything paying more than risk free (Treasury bills). The more it pays, the higher the risk.

Some investors are earning 10% on second deed trusts, not realizing that by next year, their principal will have evaporated. So just be careful out there with high paying dividend yields. They could very well be taking the dividend out of your principal.

[Anonymous]

I received some data from a private equity firm this week that shows a lot of strength in retail, commercial, and industrial rents in San Diego. Even residential rents look to be on a steady rise. The reason REITs have not taken a beating is simply because they generally hold a lot of commercial, industrial, and retail properties. The strongest San Diego real estate market is retail.

As for poway’s comments about dividends being meaningless when principal is eroding, I agree. I even mentioned that there is some risk of a commodity bubble in copper. If Southern Copper’s price falls 25-40%, the dividend will not help too much. That said, if given an option of owning dividend-less equities or dividend-paying equities in this market, you have to choose dividends. I think Morningstar’s FDL product would be preferred today but Southern Copper is still an interesting play if copper prices stay high for another year.

[(former)FormerSanDiegan]

PS –

Just because a dividend increases, doesn’t mean your investment is any better.

This is not what I wrote or intended.
I wrote, “when bond yields go down, the relative value of REIT dividends go up”

There are certainly some horrific cases where a dividend goes from 3-4% to 9-20% only because the associated stock tanks in value. This is not related in any way to the point I have made.

My point was that an investor is willing to pay more for an income stream that the REIT produces when bond rates have fallen.

Hopefully an example will solidify this …
Suppose you are out shopping for an investment and the 10-year bond pays 5.5% and a commercial REIT pays $6.50 in dividends and costs $100. Now, suppose that the 10-year bond yield goes to 4.5%. The $6.50 dividend in the REIT is now significantly more valuable. The investors that paid $100 for the REIT (1% spread over treasury) might be willing to pay $110 (1.5% spread over treasury) or even $118 (1% spread) .

[lewman]

I agree with FSD that relative yield could be one of the reasons why investors continue to put money into REITs today. I also agree with Powayseller that if the search for higher yield is the sole reason it may not be wise as REIT investors may one day realize that while they continue to get a good income stream, the value of the underlying is eroding and the extra yield doesn’t cover the loss in capital.

Having said that, the above statement is based on the assumption that the assets held in REITs, i.e. commercial properties, apartments, retail properties will go down in value. And secondly, the corresponding REITs will not trade at a premium to their underlying assets (note that REITs are basically a special type of closed end funds and I have witnessed closed end funds rising in price despite a downward revaluation of its underlying assets).

I think most of us here agree that SFR and Condo prices will go down. Are these other property types in the same camp ?

Other than logical assumptions which we often base our opinion on, has anybody looked at the facts and statistics or have first hand experience (not the anecdotal type) perhaps because you’re in the property industry ? For example, whether these types of properties go down in value when the residential properties declined in previous cycles ?

Thanks and as usual more questions than answers.

[powayseller]

I’ve written before about the economic cycle, led by wages, then consumer spending, capital spending, manufacturing, and finally unemployment.

Office buildings and commercial buildings, industrial parks, are in the capital spending and manufacturing parts of the cycle, and thus lag the consumer spending cycle by 3-9 months.

This is because current construction was entered into by late spring, when retail was still hot. I am sure, although I don’t have data on this yet, that anybody who had planned to expand their furniture factory, build a bigger mortgage office building, develop a new strip mall, or expand their car dealership, will not do so from this point on. By mid 2000, REITs will be down, as the vacancy rate will increase in the business sector.

Whenever a question arises about a sector, think about the economic cycle, and the lags between them.

Also remember that by the time a recession is identified, the worst damage is behind us. That’s how you become ahead of the curve (as Joseph Ellis’ book is titled).

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