Are REITS overvalued?

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Are REITS overvalued?

Postby garlandwhizzer » Tue Dec 11, 2012 1:26 pm

From a Morningstar Market Inisights forum.

REITs are trading at an average of 20x "funds from operations," which is a REIT measure for cash flow. (Net income or earnings for property REITs is useless, because of the depreciation charge. That means a conventional P/E is also useless.)

Anyway, they're expensive. Really expensive. The apartment landlords are insanely expensive, although they're growing rents at large clips at the moment. They're priced as if they'll do so forever. Everyone is chasing REIT yield. Stay away from them..... Unless, I suppose, you think the 10-year Treasury will yield under 2% forever......


Personally, I don't know if this FFO figure is accurate, but it is higher than the P/E of the S&P 500. Also Vanguard reports the current P/B of VGSLX is 2.2, the same as the S&P 500. In the not too distant past, REITS had a P/B of about 1, sometimes less than 1. Those low valuations turned out to be a great time to invest in REITS.

Question: are REITS overvalued relative to TSM or S&P 500 at present? If so, will this affect their future returns?

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Re: Are REITS overvalued?

Postby nisiprius » Tue Dec 11, 2012 1:30 pm

garlandwhizzer wrote:Question: are REITS overvalued relative to TSM or S&P 500 at present?
Answer: the people who buy REITs don't think so.
If so, will this affect their future returns?
If they change their minds, it will.

More seriously: a) Burton Malkiel makes a strong case for REITS, at least in every edition up to 2009, haven't read the most recent. I don't believe that case includes any concept of valuation. (I don't care much because I eventually decided I didn't agree with Malkiel and no longer have any REIT allocation other than what's in Total Stock).

b) I think there are times when a sane investor might be so sure that he is looking at a mania that he might prudently decide to wait on an investment. But I personally think that means values that look well above double what rule-of-thumb indicators say they "should be."

c) Due to the crazy flailing around people are doing looking for stocks that can substitute for bonds, it seems very likely that people have "discovered" REITS and that demand has driven up the price a bit, but is that enough to warrant acting on?
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Re: Are REITS overvalued?

Postby 4 Iron » Tue Dec 11, 2012 3:01 pm

The short answer would be yes, they are overvalued. 20x FFO is the equivalent to a 5% capitalization rate, which is very low by any historical standards and lower than capitalization rates in the private commercial real estate sector. But with the Fed's ZIRP policy and investors chasing yield, who knows where prices go from here?
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Re: Are REITS overvalued?

Postby Randomize » Tue Dec 11, 2012 5:00 pm

The huge price/book ratio seems pretty telling. Would you really spend $400k on a $200k house that will rent for $200k rates? Me neither.
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Re: Are REITS overvalued?

Postby DaveS » Tue Dec 11, 2012 9:50 pm

They are higher than I have ever seen them by almost any valuation metric. I am remembering they were about or below book in the 90's. Significantly below book in the 80's. The Vanguard site shows it's REIT fund at 2.2 times book. That is a significant figure. It roughly means you could buy two buildings on the market for the one you get by buying REIT stock.
Vanguard says the P/e is 61 which is more a reflection on the lack of agreement on how you measure P/e, but that figure is higher than I can ever remember. I think they have been talked up too much by pundit's over the years. And they further have been caught up in the dividend fad we are in. I set my allocation to them to zero when Zell liquidated Office properties. I missed the 2008 crash but also the recovery. I haven't been totally negative when people ask about them here, but that's an awful lot to pay for a low historical correlation. Dave
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Re: Are REITS overvalued?

Postby dropspoon » Wed Dec 12, 2012 12:41 am

I thought book value reflected what was paid historically, not the current market value.
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Re: Are REITS overvalued?

Postby pauliec84 » Wed Dec 12, 2012 11:49 am

Yes this is very interesting. The numbers are so off it seems to reflect some weird aspect of the accounting. Especially as reits have not had some sort of wild runnup. There returns have been consistant with other small/valuey asset classets.
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Re: Are REITS overvalued?

Postby Jerilynn » Wed Dec 12, 2012 6:58 pm

garlandwhizzer wrote:Question: are REITS overvalued relative to TSM or S&P 500 at present? If so, will this affect their future returns?

Garland Whizzer


that's not the question to ask. The question to ask is...."Will REITS be more overvalued or less overvalued in X years?" Unfortunately, there is no way to predict that.

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Re: Are REITS overvalued?

Postby DaveS » Wed Dec 12, 2012 10:17 pm

dropspoon wrote:I thought book value reflected what was paid historically, not the current market value.


Your sort of correct. Book value is the value of the assets as shown on the balance sheet divided by the number of shares. Book values can move up. Say they bought a building and then improved it raising it's value. It has no pretense to be accurate but a big difference between book value and stock market price suggests a premium is being paid for things like expected future earnings, quality management, or maybe that the stock is over priced. Growth stocks usually sell in the higher single digits of book value. Another indicator of value is the relationship between price and earnings. Right now the Vanguard site says that it's REIT fund is selling at 61 times earnings. I remember when REITS were selling for 15 times earnings in the 90's. That is a high valuation too. The S + P is about 15 times earnings currently. At the height of the tech boom some tech stocks - if they had earnings - were up around 1000 times earnings. A typical growth stock may be in the range of 30 times earnings. My finance professor once said in class he did not think god was worth more than 40 times earnings. Sacrilege, but it illustrates the point. Facebook at it's IPO was priced at 107 times earnings. Now its about half that. Dave
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Re: Are REITS overvalued?

Postby Valuethinker » Thu Dec 13, 2012 12:45 pm

DaveS wrote:
dropspoon wrote:I thought book value reflected what was paid historically, not the current market value.


Your sort of correct. Book value is the value of the assets as shown on the balance sheet divided by the number of shares. Book values can move up. Say they bought a building and then improved it raising it's value. It has no pretense to be accurate but a big difference between book value and stock market price suggests a premium is being paid for things like expected future earnings, quality management, or maybe that the stock is over priced. Growth stocks usually sell in the higher single digits of book value. Another indicator of value is the relationship between price and earnings. Right now the Vanguard site says that it's REIT fund is selling at 61 times earnings. I remember when REITS were selling for 15 times earnings in the 90's. That is a high valuation too. The S + P is about 15 times earnings currently. At the height of the tech boom some tech stocks - if they had earnings - were up around 1000 times earnings. A typical growth stock may be in the range of 30 times earnings. My finance professor once said in class he did not think god was worth more than 40 times earnings. Sacrilege, but it illustrates the point. Facebook at it's IPO was priced at 107 times earnings. Now its about half that. Dave


You cannot really value REITs on PEs because of the requirement to pay out 90% of FFO, no corporation taxes etc. Not comparable with other stocks.

You usually use price to book, dividend yield as the main factors in valuation. Particularly the discount to NAV.

In US REITs, is the Book Value marked to market? ie are the buildings revalued every year? If not, book value is not much of a guide.
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Re: Are REITS overvalued?

Postby WolfpackFan » Thu Dec 13, 2012 1:07 pm

The Vanguard site shows it's REIT fund at 2.2 times book.


Where do I look on Vanguard to see this information? I pulled up the REIT fund on Vanguard's website but now I'm just unsure where to find that book value. Thanks for you help. :)
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Re: Are REITS overvalued?

Postby Bill Bernstein » Thu Dec 13, 2012 1:35 pm

I'm a simple sort of guy who believes that dividends don't lie, particularly with REITS, which have to distribute 90% of high-quality (i.e., not gamed) earnings.

All you have to know from that starting point, currently about 3.5%, is the real dividend growth rate, which is in the -1.0% to -1.5% range for 1972-2012, according the NAREIT Equity series.

Let's be generous and use -1.0%. This gives a Gordon expected real return of 2.5% for a very volatile, highly leveraged asset class.

You be the judge.

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Re: Are REITS overvalued?

Postby Simplegift » Thu Dec 13, 2012 4:17 pm

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Re: Are REITS overvalued?

Postby billjohnson » Thu Dec 13, 2012 4:40 pm

The search for yield has definitely pushed prices higher (lower future returns). But as I said in last year's thread...doesn't mean they have to come back down to "fair value" anytime soon. I held my REIT allocation firm throughout 2012 but will be decreasing some exposure to REITS, junk bonds, etc. in 2013...as that space has just become way too crowded...regardless of what the future holds.

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Re: Are REITS overvalued?

Postby Suppertime » Fri Dec 14, 2012 4:27 am

I wonder if it is the case that REITs have been bid up by financial investors looking for yield to the point where the underlying real estate is valued significantly higher than market value of equivalent properties not held in REITs. If so, whether there is an arbitrage where you buy up properties, wrap it in a REIT and sell the shares.

Can I rely on this mechanism to get comfortable that the REIT fund I hold or buy are probably not at prices too out of wack with market prices of the underlying properties? When an acquaintance tells me about investing in office or retail rental properties, I sometimes say, why don't you just buy a REIT index fund which will give you rental income and the chance at appreciation, plus diversification and liquidity. This would make sense only if you're paying around the same price.
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Re: Are REITS overvalued?

Postby rustymutt » Fri Dec 14, 2012 8:57 am

REITS are part of my portfolio because I set it up at 10% of my total. High, or low, I bought them back in mid 09 at a great price, and have no plans to dump them anytime soon. They've done quite well for me the last 3 years. Will this continue, I doubt it, but I have a great start with it.
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Re: Are REITS overvalued?

Postby STC » Fri Dec 14, 2012 9:00 am

I'll be the one to bring up the fact that REIT's us leverage to buy hard assets. Leverage is amazingly cheap right now. In an inflationary environment, the leverage gets even cheaper in real terms while the underlying hard assets grow in value. This must also be considered along side of FFO if you want to call something expensive/cheap.
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Re: Are REITS overvalued?

Postby BBL » Fri Dec 14, 2012 9:11 am

Let me put my Bozo hat on and extrapolate [and misinterpret :happy ] this:

I'm a simple sort of guy who believes that dividends don't lie


I'm far simpler than you, sir. But yes that sounds good, I've been looking at that long bond ETF [BLV]

All you have to know from that starting point, currently about 3.5% for a very volatile asset class


Sure is - latest SEC yield figure, 3.52% and no doubt about that volatility.

You be the judge.



No problem, those long bonds look terrible - oh wait this thread is about REITS. Pardon me. :|
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Re: Are REITS overvalued?

Postby czeckers » Fri Dec 14, 2012 7:04 pm

On the other hand, the VG international REIT index fund has a P/B ration of 1.1. Given this. Ablution compared to the US REIT fund, I think that anyone who considers REITs as a separate investment class should consider international diversification within that class.

-K
The Espresso portfolio: | | 16% LCV, 16% SCV, 16% EM, 8% Int'l Value, 8% Int'l Sm, 8% US REIT, 8% Int'l REIT, 20% Inter-term US Treas | | "A journey of a thousand miles begins with a single step."
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Re: Are REITS overvalued?

Postby Randomize » Fri Dec 14, 2012 7:19 pm

czeckers wrote:On the other hand, the VG international REIT index fund has a P/B ration of 1.1. Given this. Ablution compared to the US REIT fund, I think that anyone who considers REITs as a separate investment class should consider international diversification within that class.

-K


Don't US REITs get special tax treatment that makes them more appealing? Or maybe that doesn't matter since US REITs have worse after-tax earning ratios in spite of their advantage...
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Re: Are REITS overvalued?

Postby czeckers » Sun Dec 16, 2012 9:57 am

I wouldn't hold any REITs in a taxable account.

-K
The Espresso portfolio: | | 16% LCV, 16% SCV, 16% EM, 8% Int'l Value, 8% Int'l Sm, 8% US REIT, 8% Int'l REIT, 20% Inter-term US Treas | | "A journey of a thousand miles begins with a single step."
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