## How Would Mr. Bogle Calculate Expected REIT Returns?

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Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Rodc wrote:
If the dividend yield doubled, back to historic levels of 6% say, then the price would drop to 50.

Doesn't this suppose re does not get more profitable?

I am doing what in mathematics is called a first derivative. Ie the sources of return from REITs are

- dividend yield (initial)
- dividend growth
- the speculative return ie the price the market puts on \$1 of dividends (lower yield = higher valuation, the opposite of PE)

I am fixing the first 2 factors for analysis, with a view to explaining the impact of the last factor, in effect what dividend yield the market demands long term from REITs.

If yield is down because rents are down (either per square foot when down or vacancy went up), and rents go back up, you could get a doubling of yield with no change in price. Or if folks are happy with a 3% yield they could bid prices up to \$200.

Yield is down because the price of the instrument has gone up. As I say it's a first derivative, I am holding constant the other factors.

(in finance a derivative security is basically a future option or swap, which is different).

In the latter, that is speculative return-- yield would drop to 1.5%.

your scenario is yield is down because the REIT cuts its payout because its profits are down. That's not the speculative return (the level of yield the market expects from the stock) that's simply its dividend growth.

This would be like P/E10. It can be low because E is depressed or because E10 is high.

The complexity with PE10 which is why Shiller uses a 10 year average is that earnings drop due to a recession, but the market does not usually drop as far (except in periods like the 1930s or 70s when the market becomes convinced things are never going to get better). So the PE rises.

If REITs cut their dividends, either the REIT market cap falls to hold yield steady, or the yield itself falls, presumably in the anticipation of future recovery.

Long term with stocks you expect speculative returns to be zero. If high or low at the starting date you might not, but in general over say a lifetime of monthly investing you would expect something around zero.

Why would this not be true for REITS?

Precisely so. Ie in the long run the PE of the market should be stable (in fact it never has been, itself an interesting datum, its always going up or down)-- it's not even clear it oscillates around a long run average (if it does, that average is around 15x I believe). A safe assumption is that the long run PE of stocks, or the yield on REITs, is constant.

In the case of REITs, if the long run average REIT dividend yield is 6% and we are at 3% right now, then either share prices halve from now, OR share prices go nowhere and dividend growth rises to \$6 per \$100 of REIT market value. In the case of stocks, that is more or less what has happened since 2000 (ie corporate earnings have recovered, but the PE of the stock market has steadily fallen-- roughly speaking from over 22x to about 15x).
Last edited by Valuethinker on Thu May 16, 2013 3:51 pm, edited 1 time in total.

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

bogleblitz wrote:Thanks Valuethinker for your explanation. REIT sounds just like Bonds, when interest rate rises, bond prices fall. When REIT yield rises, REIT prices fall.
I never heard of this before, I should really go back and read some investment books about REIT.

S&P500, reits, bonds all seems overpriced now.

Bonds the calculation is called Yield to Maturity, and includes both the coupons you get *and* the fact that you get \$100 par value back at maturity (so a capital gain or loss depending on what price you purchased the bond at). YTM also assumes you can reinvest the coupons at *exactly* the same YTM, in the future, as you are getting when you buy the bond.

REITs are like stocks- -they are stocks in fact. The yield is the dividend/ price. Doesn't say anything about what price you will get when/ if you sell the REIT. It's simply mathematics that if the price rises, the yield will fall. But note with a bond the price will always go back to 100 (unless a TIPS bond, or a default) at maturity. REITs can go on up forever. Conversely the Board has no legal obligation to pay a dividend-- during the 2008-09 period when commercial RE crashed, a lot of REITs cut their dividends (or paid them in stock, which is dilutive to shareholders).

The peculiar thing about REITs (and MLPs I presume) is that they have to distribute practically *all* their profits as dividends (to avoid double taxation) or they lose REIT status. For a stock, if the EPS is \$2.00 per share (EPS = profits or net income after tax/ number of shares), typically the dividend is 80 cents to \$1.00 (for a mature company in a mature industry). Whereas for a REIT that ratio would be EPS = \$1.00, DPS = 90 cents (at least).

So REITs are typically valued by yield ie the ongoing income you would get from owning the REIT (since the profits are not being reinvested in the business). Which doesn't tell you anything about what future dividends might be (hopefully they will grow with rising rents). The other thing people look at is the premium/ discount to the Net Asset Value. The NAV is the total value of the buildings (determined by external property experts) less debt / shares in issue. The share price will move between a premium to NAV (when things are pretty bullish) to a discount (in the property crash of the early 90s, c. 40% discounts).

Right now yields are at record lows and I believe premiums are mildly positive (ie the stocks are worth more than the buildings that underpin them). It is likely that yields will rise and premiums will fall, *if* interest rates return to more normal levels (no sign of that yet). Pace that, dividend growth should accelerate as the US economy recovers.

Green Street Advisers is a REIT specialist they have some stuff on their website. I am sure Larry Swedroe's books cover REITs. David Swensen's personal investing book covers REITs.

The closest thing a REIT actually matches is a Closed End Fund-- a listed company that owns a mess of buildings, collects the rent, charges a management fee, and pays out the rest as dividends to shareholders. But a fixed share capital, whereas a mutual fund can always issue new shares to new investors.

The argument we have here really boils down to whether REITs are a special asset class all their own, or simply a form of small cap stock. ie what gains are there to diversification by investing in REITs against stocks? The underlying asset (Commercial Real Estate) is a separate asset class, but direct access to that is really only possible for US individual investors *if* you have access to TIAA Real Estate annuity-- Swensens takes you through the horrors of all the 'private real estate partnerships' out there (google also 'REIT wrecks'). Every so often some poor soul washes up on shore here who has some of these (there is usually no way to sell them, you are completely at the mercy of the fund manager).

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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

The wiki has additional background information: Real Estate Investment Trust
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Valuethinker wrote:
bogleblitz wrote:
wbern wrote:Now, all we’re left to calculate is the speculative return. Mr. Bogle, I think, would say that the historical yield should be 6%, so the doubling of the yield over the next 10 years should detract 7% pa from the return.

I'm a newbie. Reading this many times, and I still don't understand the speculative return. Why is it negative? how did 6% become -7%? Does the S&P 500 index fund VTSMX have this -7% speculative return? Thanks in advance

Yield is dividend/ price.

Say the price is 100 now and the yield is 3% so dividend is 3.

If the dividend yield doubled, back to historic levels of 6% say, then the price would drop to 50. That is called derating.

The thing with REITs is they distribute 90%+ of their profits (Earnings Per Share) by law.

So whereas for other equities we talk about PE ratios, the S&P500 is on 15 times say, having doubled from 8 times in 1980, and whether that can keep going or will it go back (in practice it went to well over 20X in 2000, and since then although profits have gone up and thus EPS, the PE has been falling pretty steadily, rebounding somewhat after 2009). But for REITs we talk about yields (dividend/ price, but in a REIT your dividends per share are pretty close to your earnings per share, because of the 90% rule). Yield going up is a fall in valuation, yield going down is a rise in price/ valuation.

But with REITs we say we are going to get the following sources of return

the existing yield 3%
+ likely growth in dividends say 3-4%
+/- rating or derating (a rise in the value the market puts on those dividends)

We have to factor in a 'derating' (rise in yields, fall in PE ratios) or a 'rerating' (rise in PE, like the S&P500 experienced 1980-2000, or a fall in dividend yields).

If we assume a derating of REITs back to 6%, that's going to hit your returns. Say it happens over 10 years, then by about -7% pa.

The counterargument to saying REITs will go back to historic 6-7% yields is that ALL assets have lower yields now, especially risk free bonds (and therefore everything else).

That's a great tutorial (along with the subsequent posts. If it's appropriate, is there any way this could be put into the wiki article? Real Estate Investment Trust

I don't have the confidence to do this myself (I don't own REITs). If someone can provide the wording, I'll do the editing.
To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.

Rodc
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

I am fixing the first 2 factors for analysis, with a view to explaining the impact of the last factor,

The problem is that you have simply assumed away other real-world answers as to why yield can change. In the real world those factors are rarely fixed. Which was my point.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Rodc wrote:
I am fixing the first 2 factors for analysis, with a view to explaining the impact of the last factor,

The problem is that you have simply assumed away other real-world answers as to why yield can change. In the real world those factors are rarely fixed. Which was my point.

In the formula I have used, William Bernstein and I have accounted for ALL possible sources of return in owning a REIT: current income, income growth and capital appreciation.

That is how you use derivatives (I only mention that because often DH have science or engineering backgrounds, and it makes things more clear to them to name the mathematical principle)-- to separate out these factors.

So there is no 'other' source of return that you can have by varying 2 factors together at once.

If you want to figure out the expected return of a REIT, you need to estimate:

- current yield (that's easy)
- yield growth (hard, but Wm Bernstein gives you a clue from history)
- the valuation the market will put on the dividend in the future (aka the 'rating': PE for normal stocks, yield for REITs) - and we've assumed that it is likely to show mean reversion in the long run

Recent performance of REITs has been all about the 3rd factor (dividend/ price) falling in line with the 'quest for yield' and lower interest rates. Equivalent to the PE of other stocks rising.

The problem is that you have simply assumed away other real-world answers as to why yield can change. In the real world those factors are rarely fixed. Which was my point.

So you are arguing for a permanent change in the yield? ie against reversion to the mean?

Or for higher dividend growth than historic?

Rodc
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

As I have a PhD in math and have a successful multi-decade career, so you are correct that I have a basic working knowledge of what a first derivative is. However that completely misses the point it seems to me.

If the dividend yield doubled, back to historic levels of 6% say, then the price would drop to 50.

That is a bold, specific and precise statement phrased as a hard and fast fact. But it is not a hard and fast fact. It is stated as cause and effect, but the arrow of causality can run the other way. This is like saying if P/E10 doubles, then P would double (note that P can drive P/E10 as opposed to P/E10 driving P). We know that P is not only factor that can change. Similarly, P is not the only factor that can change in REIT yields. That is the only point I am making.

So the calculation is overly simplified.

It reminds me of similar problems with the Gordon equation. Dividend yield can be low because price is high, profits are low so divs are low, because profits are high but companies are using stock buy backs to return value rather than through divs and so divs are low. All of which effect expectations for dividend growth and the speculative component, and thus expected returns going forward. Most uses of the Gordon equation simply assume a generic one-size fits all dividend growth rate which ignores these factors. If I am going to string along a few different factors and one important factor is garbage (as in garbage in) the whole thing becomes garbage (as in garbage out).

I don't know where REITS are headed. Or stocks or bonds. I'd prefer yields (real) were higher. Simple little models hint at lower than average returns, and they may be correct which is why I have increased savings rate. But then simply little models (or sophisticated for that matter) are so frequently wrong that economic prognosticators make weather forecasters look good.

At the very least people who use the Gordon equation, the REIT calculation above, etc., should be very clear and explicit regarding the very significant simplifications they are making, and their effects. The errors bars swamp the signal in most cases.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Rodc wrote:As I have a PhD in math and have a successful multi-decade career, so you are correct that I have a basic working knowledge of what a first derivative is. However that completely misses the point it seems to me.

If the dividend yield doubled, back to historic levels of 6% say, then the price would drop to 50.

I did not know what your background was so I was not being condescending. I was searching for a common language, and many readers have that. I have seen many a finance expert or economist confuse a lay audience, because they cannot simply state what is going on mathematically (not everyone has calculus) when simply writing an equation would simplify it for many people.

Two comments from my economics profs:
'I had a Phd engineering student in my class, he looked lost, finally I just wrote the equation on the board, and he went 'oh, that is obvious'''
'Avert your eyes now if you do not like mathematics'

That is a bold, specific and precise statement phrased as a hard and fast fact. But it is not a hard and fast fact. It is stated as cause and effect, but the arrow of causality can run the other way. This is like saying if P/E10 doubles, then P would double (note that P can drive P/E10 as opposed to P/E10 driving P). We know that P is not only factor that can change. Similarly, P is not the only factor that can change in REIT yields. That is the only point I am making.

In understanding where returns on a stock come from, they come from 1). the current dividend yield 2). future dividends (ie growth in earnings that is paid out) and 3). the price the market will put on those earnings (future PE). That's simply mathematics.

Because of the payout rule (90% US GAAP earnings) for REITs we use dividend yield, not EPS.

If the stock price halves, and the dividend is held constant, then the yield doubles. And our return is -50%.

When you say 'other factors can change' precisely so: that's 2 (future dividends ie growth) and 3 (the demanded level of yield or PE the market requires).
So the calculation is overly simplified.

Not at all. It is tautological.

It reminds me of similar problems with the Gordon equation. Dividend yield can be low because price is high, profits are low so divs are low, because profits are high but companies are using stock buy backs to return value rather than through divs and so divs are low.

Buybacks increase EPS in the future, and therefore DPS, potentially. Most analyses using the Gordon Model make an assumption about level of buybacks (typically 0.5-1-1.0% pa increase in yield).

I have a slight thing about the Gordon model, one of my finance lecturers was --- Myron J Gordon! This was a long time ago, though.

All of which effect expectations for dividend growth and the speculative component, and thus expected returns going forward. Most uses of the Gordon equation simply assume a generic one-size fits all dividend growth rate which ignores these factors.

The speculative return (component 3) is altered by future expectations. Also you have to make an assumption about dividend growth.

If I am going to string along a few different factors and one important factor is garbage (as in garbage in) the whole thing becomes garbage (as in garbage out).

Your parametric inputs can be wrong, but the model is correct.

I don't know where REITS are headed. Or stocks or bonds. I'd prefer yields (real) were higher. Simple little models hint at lower than average returns, and they may be correct which is why I have increased savings rate. But then simply little models (or sophisticated for that matter) are so frequently wrong that economic prognosticators make weather forecasters look good.

On weather forecasters I think they do rather well. The 5 day forecast now is as accurate as the 1 day forecast 30 years ago. However we have reached the likely limits of modelling complex chaotic systems. Perhaps with more exact real time data we could do better, but I don't believe anyone is hopeful that even more computing power will lead large improvements.

Real yields are unknowable because they rely on outcome inflation (an ex ante guess is expected inflation which we can only infer).

Economics I just don't think you can model like the weather, or climate, because there are not physical laws here and the data is not measurable in the same way. But history is still a useful guide-- permanent structural change is just not that common. Things revert.

At the very least people who use the Gordon equation, the REIT calculation above, etc., should be very clear and explicit regarding the very significant simplifications they are making, and their effects. The errors bars swamp the signal in most cases.

I have tried to lay out where I think Wm Bernstein is coming from. And I implicitly agree with him. That we would expect 'reversion to the mean' in terms of the demanded yield (equivalent of PE) on REITs in the long run, and that profits (and dividends) growth would also probably track historical growth. Those are fairly conservative tenets of value investing generally.

The problem with the data is that it is pretty clearly not simply a random walk around some mean that we revert to. Instead there are long 'waves' up and down and serial correlation. The annual data isn't telling us much. A general problem with analysis of security returns (takes us back to Mandelbrot's cotton prices, ie that financial returns are inherently fractal).

Illmanen notes (I have written a piece for the Wiki and hopefully it wasn't lost in latest shenanigans, Lady Geek should be publishing it at some point) re his analysis, and his basic conclusion is that the prospective return on REITs seems highly dependent upon where you start in valuation (ie yield) terms.

That's the same simplification we use in forecasting bond yields (that the best guess of likely return is Yield to Maturity).

lazyday
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Valuethinker wrote:Also you have to make an assumption about dividend growth.

This is the problem!

--Talking about general equity, not REITS.
I've always had problems with the Gordon Equation, with some analysis much better than others. Never had confidence to try my own.

Corporations can use profits for dividends, stockpiling cash, buybacks, mergers/reorginizations, internal investment.

That split might change over time. Sometimes, growth might be pent up, most simply by stockpiling cash. If later spent in a fury, dividends could grow quickly.

Also, productivity might change over time. Profit margins might change over time. Growth might change over time, such as with technology booms or resource tightening.

It could be risky to just use past dividend growth rates, even if they have been relatively steady--they world may have changed. Laws impacting dividends have changed. Productivity improvements caused by women entering the workforce have ended.
Some of these effects may cancel each other out, but there might be large ones remaining.

Not claiming is useless, but imperfect, needs tweaking, and maybe should also use other methods.

Sorry been awhile since read or really thought about Gordon Eq, may not be quite logical on it, but hope am close...or maybe I never was.

Rodc
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Also you have to make an assumption about dividend growth

Well, to be more precise, if you insist on building a model, regardless of the quality of its predictions, you have to make assumptions.

As lazyday says, this is the problem with all these models. One is forced to not only make assumptions, but generally assumptions that simplify away too many factors. For example one tends to assume things that are not constant are constant.

I have not seen plots of Gordon vs reality or REIT predictions vs reality. It would be enlightening to see such a thing. I have seen various plots of P/E10 base predictions, Tobin’s q based predictions, bond interest rate predictions, inflation rate predictions vs reality. None of them have enough skill to provide much actionable value, IMHO. In particular they seem to never predict when things will change, which is perhaps the most important thing to predict. Not surprising when folks take current conditions and add in some constant factors like historical long term dividend growth rate. Or they assume rents won’t jump or vacancies won’t rise.

In the end the models might have some value in illuminating some limited set of economic behavior. I think Modern Portfolio theory for example is like this. It gives a nice mathematical demonstration of how diversification among risky assets can result in a portfolio with a better risk adjusted return than simply averaging the risk and return of the parts. But you can’t use it very well to actually build a portfolio because you don’t have sufficient knowledge of the inputs.

The REIT model, Gordon Equation, do I think have some value in illuminating some points. I don’t think we should take the results very seriously as actually being useful. I understand others, such as Bernstein feel otherwise.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

swaption
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Valuethinker wrote:If the stock price halves, and the dividend is held constant, then the yield doubles. And our return is -50%.

When you say 'other factors can change' precisely so: that's 2 (future dividends ie growth) and 3 (the demanded level of yield or PE the market requires).
So the calculation is overly simplified.

Not at all. It is tautological.

You are right, it is tautological. But I will reiterate what I said earlier, the argument is hollow for much simpler reasons. Why would the price of a given cash flow be X today and 50% of X tomorrow, assuming things like growth held constant. The answer is simple, some combination of real interest rates and risk premium. Generally, the notion of speculative return ends up being a laymen's term for a widening risk premium. Given the state of things today, I'd be more inclined to cast a vote for something related to real interest rates. But that's a bet on the whole world of asset prices and returns, certainly not limited to REITs.

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

lazyday wrote:
Valuethinker wrote:Also you have to make an assumption about dividend growth.

This is the problem!

--Talking about general equity, not REITS.
I've always had problems with the Gordon Equation, with some analysis much better than others. Never had confidence to try my own.

Corporations can use profits for dividends, stockpiling cash, buybacks, mergers/reorginizations, internal investment.

That split might change over time. Sometimes, growth might be pent up, most simply by stockpiling cash. If later spent in a fury, dividends could grow quickly.

Also, productivity might change over time. Profit margins might change over time. Growth might change over time, such as with technology booms or resource tightening.

It could be risky to just use past dividend growth rates, even if they have been relatively steady--they world may have changed. Laws impacting dividends have changed. Productivity improvements caused by women entering the workforce have ended.
Some of these effects may cancel each other out, but there might be large ones remaining.

Not claiming is useless, but imperfect, needs tweaking, and maybe should also use other methods.

Sorry been awhile since read or really thought about Gordon Eq, may not be quite logical on it, but hope am close...or maybe I never was.

REITs you have the advantage of the 90% payout rule of US GAAP earnings. Therefore dividends growth approximates earnings growth.

It's possible, if not certain, that earnings growth generally reverts to a mean-- William Bernstein bases most of his valuation arguments on that truth.

In the last 3 decades corporate profits have accelerated relative to sales, capital, GDP. At the expense of wages and salaries. Whether that will continue is anyone's guess, we don't full understand why it has been happening (globalization and offshoring probably a significant part, also the decline of organized trade unionism in most countries since the 1970s).

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Rodc wrote:
Also you have to make an assumption about dividend growth

Well, to be more precise, if you insist on building a model, regardless of the quality of its predictions, you have to make assumptions.

As lazyday says, this is the problem with all these models. One is forced to not only make assumptions, but generally assumptions that simplify away too many factors. For example one tends to assume things that are not constant are constant.

I have not seen plots of Gordon vs reality or REIT predictions vs reality. It would be enlightening to see such a thing.

If my piece gets to the wiki, it cites the relevant paper (by Ruff, from memory) that Illmanen uses.

I have seen various plots of P/E10 base predictions, Tobin’s q based predictions, bond interest rate predictions, inflation rate predictions vs reality. None of them have enough skill to provide much actionable value, IMHO. In particular they seem to never predict when things will change, which is perhaps the most important thing to predict. Not surprising when folks take current conditions and add in some constant factors like historical long term dividend growth rate. Or they assume rents won’t jump or vacancies won’t rise.

Andrew Smithers is pretty hot on q, and as I recall his books (Valuing Wall Street and the other one) seemed to have a lot of predictive power. He also shows how it maps onto Shillers PE10. However you are right neither will call turning points-- things like 2000 just seem to happen.

In the end the models might have some value in illuminating some limited set of economic behavior. I think Modern Portfolio theory for example is like this. It gives a nice mathematical demonstration of how diversification among risky assets can result in a portfolio with a better risk adjusted return than simply averaging the risk and return of the parts. But you can’t use it very well to actually build a portfolio because you don’t have sufficient knowledge of the inputs.

The REIT model, Gordon Equation, do I think have some value in illuminating some points. I don’t think we should take the results very seriously as actually being useful. I understand others, such as Bernstein feel otherwise.

The interesting thing about market efficiency is that individual asset prices seem to be efficient (you cannot pick stocks) but asset classes seem to show clear trends of over and undervaluation. Schleifer wrote a great great piece on why that might be so (it's in Oxford papers on economic activity) the whole question of 'noisy traders' and 'rational bubbles'. Basically the problem of The Big Short -- a rational man can see that an asset is overvalued, but may be limited from betting against it. In fact might be better off just jumping on the bubble.

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

swaption wrote:
Valuethinker wrote:If the stock price halves, and the dividend is held constant, then the yield doubles. And our return is -50%.

When you say 'other factors can change' precisely so: that's 2 (future dividends ie growth) and 3 (the demanded level of yield or PE the market requires).
So the calculation is overly simplified.

Not at all. It is tautological.

You are right, it is tautological. But I will reiterate what I said earlier, the argument is hollow for much simpler reasons. Why would the price of a given cash flow be X today and 50% of X tomorrow, assuming things like growth held constant. The answer is simple, some combination of real interest rates and risk premium. Generally, the notion of speculative return ends up being a laymen's term for a widening risk premium. Given the state of things today, I'd be more inclined to cast a vote for something related to real interest rates. But that's a bet on the whole world of asset prices and returns, certainly not limited to REITs.

If you look at the cycle of discounts on REITs over the long run, there's another factor. RE is, secularly, a boom and bust market-- the underlying asset has inherent volatility. I explained why above and will in the wiki if it gets there. But it basically boils down to the time lags in the construction of RE , plus forecast error (in other words the Jay Forrester Dennis and Donella Meadows John Moorcroft Systems Dynamics theory stuff), plus the way banking works (Loan to Value ratios).

It's harder to map it to real interest rates or any purely financial factor. What drives RE valuation is the boom bust cycle and underlying GDP growth. Then you get the financial crises (S&L 1990, Credit Crunch 2008) overlaid on top. To be fair 2008-09 was not your 1990 style CRE oversupply bust, it was a valuation driven bust arising out of the debt bubble.

The market decides we are headed for another RE bust, and valuations will halve-- not overnight, but in relatively quick time (a few years). See Japan. Or the UK in the early 1990s.

swaption
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Valuethinker wrote:
swaption wrote:
Valuethinker wrote:If the stock price halves, and the dividend is held constant, then the yield doubles. And our return is -50%.

When you say 'other factors can change' precisely so: that's 2 (future dividends ie growth) and 3 (the demanded level of yield or PE the market requires).
So the calculation is overly simplified.

Not at all. It is tautological.

You are right, it is tautological. But I will reiterate what I said earlier, the argument is hollow for much simpler reasons. Why would the price of a given cash flow be X today and 50% of X tomorrow, assuming things like growth held constant. The answer is simple, some combination of real interest rates and risk premium. Generally, the notion of speculative return ends up being a laymen's term for a widening risk premium. Given the state of things today, I'd be more inclined to cast a vote for something related to real interest rates. But that's a bet on the whole world of asset prices and returns, certainly not limited to REITs.

If you look at the cycle of discounts on REITs over the long run, there's another factor. RE is, secularly, a boom and bust market-- the underlying asset has inherent volatility. I explained why above and will in the wiki if it gets there. But it basically boils down to the time lags in the construction of RE , plus forecast error (in other words the Jay Forrester Dennis and Donella Meadows John Moorcroft Systems Dynamics theory stuff), plus the way banking works (Loan to Value ratios).

It's harder to map it to real interest rates or any purely financial factor. What drives RE valuation is the boom bust cycle and underlying GDP growth.

The market decides we are headed for another RE bust, and valuations will halve-- not overnight, but in relatively quick time (a few years). See Japan. Or the UK in the early 1990s.

OK, I'll now summarize the above. Rodc claims the speculative return concept is far more complex than presented, to which you claim in isolation it is actually tautological, to which I agree, but then summarize the implications of such a simplified view, to which you then claim such implications are not valid for reasons more complex than those originally presented by Rodc. I suddenly feel like a dog chasing my tail. The whole world is complex and subject to cycles, not just real estate.

But I'm not going to get into a whole complex discussion of real estate cycles, valuation, or banking cycles. I'd say I tapped out my complexity quota in some of my earlier responses. That's not where Dr. Bernstein was going either.

Rodc
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Andrew Smithers is pretty hot on q, and as I recall his books (Valuing Wall Street and the other one) seemed to have a lot of predictive power. He also shows how it maps onto Shillers PE10. However you are right neither will call turning points-- things like 2000 just seem to happen.

So it has lots if predictive power as long as things are pretty well constant? (ie not much to predict)

This is a look at using q as a portfolio timing trigger. It did show some skill on past data once I did some data mining on that data. However only on the time period used to develop q and then failed for the next 40 years.

http://home.comcast.net/~rodec/finance/ ... mingV2.pdf

From the conclusion: The initial attempts to use q as the basis for a “valuation matters” algorithm to improve portfolio performance failed. However, when the portfolio switching is stabilized by time smoothing q, the “valuation matters” approach did provide benefits, beating buy and hold frequently (72 wins to 17 losses) and by a solid margin (approximately 14% or 25% in total dollars over an investment period of 20 years).
Interestingly, and perhaps unfortunately, the vast majority of the out-performance came in approximately the first 50 of the 89 rolling 20-year periods available. Very little if any benefit has been provided for nearly 40 years. The q-timing approach as examined here, with or without smoothing would have failed to provide protection in the recent downturn. While one can certainly imagine other timing algorithms based on q that would have pulled an investor out of stocks prior to this downturn, it would remain to show an over-all benefit, and perhaps more importantly, one has to fear that classic downfall of so many investing methodologies, data mining.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

lazyday
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Valuethinker wrote:The interesting thing about market efficiency is that individual asset prices seem to be efficient (you cannot pick stocks) but asset classes seem to show clear trends of over and undervaluation. Schleifer wrote a great great piece on why that might be so (it's in Oxford papers on economic activity) [snip]

Do you know the approximate year?
Andrei Shleifer?

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

lazyday wrote:
Valuethinker wrote:The interesting thing about market efficiency is that individual asset prices seem to be efficient (you cannot pick stocks) but asset classes seem to show clear trends of over and undervaluation. Schleifer wrote a great great piece on why that might be so (it's in Oxford papers on economic activity) [snip]

Do you know the approximate year?
Andrei Shleifer?

http://scholar.harvard.edu/files/shleif ... itrage.pdf

http://scholar.harvard.edu/shleifer/pub ... al-markets

http://scholar.harvard.edu/shleifer/pub ... nt-markets

You are right, I presume Shleifer is a transliteration of his Russian name, whereas if it were a German name that emigrated directly to America, it would be Schleifer more like-- and so I have this mental block on the correct spelling.

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

swaption wrote:
Valuethinker wrote:
swaption wrote:
Valuethinker wrote:If the stock price halves, and the dividend is held constant, then the yield doubles. And our return is -50%.

When you say 'other factors can change' precisely so: that's 2 (future dividends ie growth) and 3 (the demanded level of yield or PE the market requires).
So the calculation is overly simplified.

Not at all. It is tautological.

You are right, it is tautological. But I will reiterate what I said earlier, the argument is hollow for much simpler reasons. Why would the price of a given cash flow be X today and 50% of X tomorrow, assuming things like growth held constant. The answer is simple, some combination of real interest rates and risk premium. Generally, the notion of speculative return ends up being a laymen's term for a widening risk premium. Given the state of things today, I'd be more inclined to cast a vote for something related to real interest rates. But that's a bet on the whole world of asset prices and returns, certainly not limited to REITs.

If you look at the cycle of discounts on REITs over the long run, there's another factor. RE is, secularly, a boom and bust market-- the underlying asset has inherent volatility. I explained why above and will in the wiki if it gets there. But it basically boils down to the time lags in the construction of RE , plus forecast error (in other words the Jay Forrester Dennis and Donella Meadows John Moorcroft Systems Dynamics theory stuff), plus the way banking works (Loan to Value ratios).

It's harder to map it to real interest rates or any purely financial factor. What drives RE valuation is the boom bust cycle and underlying GDP growth.

The market decides we are headed for another RE bust, and valuations will halve-- not overnight, but in relatively quick time (a few years). See Japan. Or the UK in the early 1990s.

OK, I'll now summarize the above. Rodc claims the speculative return concept is far more complex than presented, to which you claim in isolation it is actually tautological, to which I agree, but then summarize the implications of such a simplified view,

The speculative return is, exactly and mathematically, the impact on the ending value arising from the change in the price the market puts on the earnings of a company (PE) or in the case of a REIT, it's equivalent to use Dividend Yield.

The 2 other sources of return (and this is simply mathematics) are your starting yield, and your dividend growth.

*Why* those factors might vary, and why that might be different from history, is an interesting question in which case we have to dig into fundamentals. In my experience it's usually best to assume that things revert to the mean, eventually.

to which you then claim such implications are not valid for reasons more complex than those originally presented by Rodc. I suddenly feel like a dog chasing my tail. The whole world is complex and subject to cycles, not just real estate.

The point is that to assume that the yield on REITs is going to go to 1% say, from 3% now, or 6% now from 3% now, you have to assume something about the state of the future world. And that something is either reversion to the mean (going back to 6%) or 'it's different this time' (that's the 1%). The former gives you a negative speculative return, the latter a positive one.

What Ilmanen notes is that, historically, where you started on REIT yields tends to have a significant impact on your future returns.

In other words, and this is what Bernstein is saying, it's better to assume that the world hasn't fundamentally changed, and that REITs will find their way back to their long term average return-- which would imply a negative speculative return, going forward.

But I'm not going to get into a whole complex discussion of real estate cycles, valuation, or banking cycles. I'd say I tapped out my complexity quota in some of my earlier responses.

I was attempting to explain the underlying logic about where dividend growth and valuation change comes from. Why CRE is cyclical (there is an argument that with more public, listed vehicles (REITs), market foresight should dampen that volatility-- given what we've lived through in 2008-09, I have to say I think the argument that financial institutions are making decisions with better foresight seems greatly weakened)... within the macroeconomy, the biggest single variable in GDP growth is business fixed investment, and the biggest single variable in that is business fixed investment in structures-- ie commercial real estate. So this is not trivial, because it's at the centre point of why economies have unstable growth (think the Thai property crash and the impact of *that* ie the entire 1997-98 crash).

That's not where Dr. Bernstein was going either.
[/quote]

It is precisely what Dr. Bernstein was going. CRE is cyclical, therefore REIT yields are probably cyclical. He also notes the historic growth record of REIT dividends (which is somewhat less than one might, prema facie, expect). He's made that point about EPS generally in fact.

The formula he uses is the conventional one asset allocators try to use to figure out expected returns from an asset class.

Note John Bogle used the same analysis in a paper around 2000 to forecast returns for equities and for bonds.
Last edited by Valuethinker on Sat May 25, 2013 3:31 am, edited 1 time in total.

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

The analysis I have used is the standard one used by professional RE asset allocators. The thoughts about macroeconomic instability are my own (but anyone who covers CRE would agree with me about the outcome, ie the cycles of the sector, if not the sources of that). The rest is precisely what the professionals use, working for (in this case) large UK insurance companies.

I have tried to give as much insight as I can, and I cannot really take the collective understanding any further, at this point.

swaption
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Valuethinker wrote:The analysis I have used is the standard one used by professional RE asset allocators. The thoughts about macroeconomic instability are my own (but anyone who covers CRE would agree with me about the outcome, ie the cycles of the sector, if not the sources of that). The rest is precisely what the professionals use, working for (in this case) large UK insurance companies.

I have tried to give as much insight as I can, and I cannot really take the collective understanding any further, at this point.

You know, I used to use a real name on the M* Boards back when I was actually somebody on these boards. But the combination of my occasionally candid tone and my general aversion to a threatening e-mail I received compelled a different approach. But in either case I made a point to never fall back on things like credentials or whatever in debating the various issues. My preference was always for the content. But I can't help but notice in Rodc's link an MIT affiliation, which is something I share, albeit in excess of a couple of decades removed. In the interim I have worked in finance and banking for the most part with a seat at the table with many of the types of professionals that you so kindly feel the need to reference.

But coming back to the topic at hand. Sometimes things are quite complex. I'm certainly not averse to going that direction when warranted, as those that were involved in the discourse regarding the duration of an I Bond can attest to. But in this case we are simply talking about cash flow and the price of cash flow. I will reference Dr. Bernstein's original equation to emphasize this point:

ER = dividend yield + dividend/earnings growth + speculative return

The first two terms are essentially cash flow. The last term is the price the market puts on the cash flow. The reason why folks like this equation is that it is both simple and true for just about everything. While I certainly appreciate all of the complexities you reference above, for the most part these relate to the cash flow component. To some extent it also extends to the speculative return component, but only to the extent that it manifests itself in the form of the risk premium or real rates, which certainly can by cyclical in the way you describe. So at the end of the day, the speculative return component does just boil down to the risk premium and real rates, and I have already offered up my thoughts on that.

Rodc
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

I think if we could just agree that this model is good only to make simple back of the envelop estimates we'd find common ground more easy to come by.

It is not so that the model is "wrong", so much as an estimate derived from the model being based on back of the envelop assumptions is not very actionable (IMHO). Thus the model is ok used as an illustration, not so much good for actionable information.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

lazyday
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Valuethinker wrote:The interesting thing about market efficiency is that individual asset prices seem to be efficient (you cannot pick stocks) but asset classes seem to show clear trends of over and undervaluation. Schleifer wrote a great great piece on why that might be so (

I buy the limit to arbitrage.

But don’t follow how asset classes are led to be mispriced while individual securities are kept efficient.

Don’t have the background to follow the models and equations. There’s a model for mispricing of asset classes, but seems to me individual securities could be mispriced by same/similiar logic.

lazyday
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Rodc wrote:, not so much good for actionable information.

Not even in extreme situations?

In case of equities US 1999? Japan near peak?
Or cheap markets, like US around 1980.

In some situations, like 1999, one might have noticed that US largecap stocks seemed very expensive, but other equity asset classes did not seem so expensive.

In 1980s and 1990s, an international investor may have avoided Japan.

Weaker mispricings might be ignored.

Rick Ferri
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

I'm not so worried about REITs. I'm more worried about what to do when low interest rates drive the PE on stocks up to 25. What do we invest in then?

Rick Ferri
Choose a few low-cost index funds in different asset classes, rebalance occasionally and forgetaboutit!

schuyler74
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Rick Ferri wrote:I'm not so worried about REITs. I'm more worried about what to do when low interest rates drive the PE on stocks up to 25. What do we invest in then?

Commodities!

Rick Ferri
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Maybe, someday in a distant future, you may be right, at least for a short while. Timing is everything with commodities. Either you buy and sell at the right time and win, or buy and sell at the wrong time and lose. They're really isn't anything in between.

Rick Ferri
Choose a few low-cost index funds in different asset classes, rebalance occasionally and forgetaboutit!

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

swaption wrote:
Valuethinker wrote:The analysis I have used is the standard one used by professional RE asset allocators. The thoughts about macroeconomic instability are my own (but anyone who covers CRE would agree with me about the outcome, ie the cycles of the sector, if not the sources of that). The rest is precisely what the professionals use, working for (in this case) large UK insurance companies.

I have tried to give as much insight as I can, and I cannot really take the collective understanding any further, at this point.

You know, I used to use a real name on the M* Boards back when I was actually somebody on these boards. But the combination of my occasionally candid tone and my general aversion to a threatening e-mail I received compelled a different approach. But in either case I made a point to never fall back on things like credentials or whatever in debating the various issues. My preference was always for the content. But I can't help but notice in Rodc's link an MIT affiliation, which is something I share, albeit in excess of a couple of decades removed. In the interim I have worked in finance and banking for the most part with a seat at the table with many of the types of professionals that you so kindly feel the need to reference.

If you sat with those professionals then they would have said the same things that the ones said to me. The transatlantic thinking is not that different. It's also the standard CFA stuff (and probably the CAIA syllabus-- I haven't checked that).

Whatever you think of my experience, I can only tell you what I am telling you is pretty orthodox-- this is how people think about these things. I have written a piece based on what Antti Illmanen says (basically reporting what he says) but I am not sure it will go into the wiki. The paper he cites is by Ruff.

The Systems Dynamics stuff is more a business school thing-- but there's a 2 page piece in Jon Sterman's textbook on the very subject. I was more interested in the semiconductor cycle (I had more direct experience of that) but similar dynamics apply. Economists and SD people don't seem to talk to each other- more is the pity.

But coming back to the topic at hand. Sometimes things are quite complex. I'm certainly not averse to going that direction when warranted, as those that were involved in the discourse regarding the duration of an I Bond can attest to. But in this case we are simply talking about cash flow and the price of cash flow. I will reference Dr. Bernstein's original equation to emphasize this point:

ER = dividend yield + dividend/earnings growth + speculative return

The first two terms are essentially cash flow. The last term is the price the market puts on the cash flow. The reason why folks like this equation is that it is both simple and true for just about everything. While I certainly appreciate all of the complexities you reference above, for the most part these relate to the cash flow component. To some extent it also extends to the speculative return component, but only to the extent that it manifests itself in the form of the risk premium or real rates, which certainly can by cyclical in the way you describe. So at the end of the day, the speculative return component does just boil down to the risk premium and real rates, and I have already offered up my thoughts on that.
[/quote]

Then we are not disagreeing.

The secular cycle of CRE has a big impact. *that* I think is about the nature of the real economy, and real interest rates aren't the be all and end all of it (real interest rates affect *all* asset prices, CRE has its own secular cycle underlying that).

If you have been in finance as long as you say, then you have lived through as many of the CRE cycles as I have. Remember 1990? 1980 in the oil belt? Also you will remember when the property stocks (I am talking UK, US wasn't much different I don't think) traded at premiums to NAV/ yield discounts in the late 80s, then collapsed in the early 90s, then basicaly lagged for 10 years until the dot com blowup.

This wasn't a story about real interest rates, particularly (they rose sharply in the early 1990s and then fell away). It was a story about market valuations of RE assets, based on expectations of the cycle.

If our current yield is 3%, and our long term 'average' (pace all my concerns about averages given what we know about the apparently fractal nature of security returns) is 6%, then it's a fair bet we will revert to the mean at some point-- implying a negative speculative return.
Last edited by Valuethinker on Sun May 26, 2013 6:31 am, edited 1 time in total.

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

lazyday wrote:
Valuethinker wrote:The interesting thing about market efficiency is that individual asset prices seem to be efficient (you cannot pick stocks) but asset classes seem to show clear trends of over and undervaluation. Schleifer wrote a great great piece on why that might be so (

I buy the limit to arbitrage.

But don’t follow how asset classes are led to be mispriced while individual securities are kept efficient.

Don’t have the background to follow the models and equations. There’s a model for mispricing of asset classes, but seems to me individual securities could be mispriced by same/similiar logic.

Think about how you 'short' US residential housing, or Thai commercial RE. Jim Charnos trying to short China.

It's not easy. There are borrowing limits to arbitrage. You get margin called. In addition, there are not actually derivatives on a lot of the underlying assets. That's the trouble Eisman, Bury et al got into in 'The Big Short'. You have to be quite creative.

So it's not easy to short because of an absence of securities or derivatives that let you do that and even if you do, you can get margin called.

However it's relatively easy to pick one housebuilder against another: the public information is all there, downloadable.

swaption
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

VT,

I can only shake my head at this point. I am familiar with system dynamics, and actually had some exposure to Sterman at MIT, although never took his class (probably regret that). I have also completed the CFA program. I also assure you that I 'have been in finance as long as you say'. Bu you essentially agree with me, then go into a long complex dissertation culminating in the following:

If you have been in finance as long as you say, then you have lived through as many of the CRE cycles as I have. Remember 1990? 1980 in the oil belt? Also you will remember when the property stocks (I am talking UK, US wasn't much different I don't think) traded at premiums to NAV/ yield discounts in the late 80s, then collapsed in the early 90s, then basicaly lagged for 10 years until the dot com blowup.

This wasn't a story about real interest rates, particularly (they rose sharply in the early 1990s and then fell away). It was a story about market valuations of RE assets, based on expectations of the cycle.

If our current yield is 3%, and our long term 'average' (pace all my concerns about averages given what we know about the apparently fractal nature of security returns) is 6%, then it's a fair bet we will revert to the mean at some point-- implying a negative speculative return.

The answer is simply no. The speculative return is almost by definition comprised of the risk premium and real rates and it is for everything. Sure these are cyclical and there may be theories for the patterns. My personal preference for the risk premium is something along the lines of the predator - prey model, for a variety of reasons that are not entirely necessary to get into right now. But like system dynamics, it's a path dependent feedback mechanism. So there you have it, I even threw in some applied math concepts for you.

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

swaption wrote:VT,

I can only shake my head at this point. I am familiar with system dynamics, and actually had some exposure to Sterman at MIT, although never took his class (probably regret that). I have also completed the CFA program. I also assure you that I 'have been in finance as long as you say'. Bu you essentially agree with me, then go into a long complex dissertation culminating in the following:

Rather the next paragraph ie not a 'long complex dissertation' at all.

I sense from your tone you are going to be dismissive whatever I say-- you are signalling a disinterest in further conversation. Fine.

Predator prey is an interesting concept and I would have to do more research to understand what you mean-- so thank you for that.

Rodc
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

lazyday wrote:
Rodc wrote:, not so much good for actionable information.

Not even in extreme situations?

In case of equities US 1999? Japan near peak?
Or cheap markets, like US around 1980.

In some situations, like 1999, one might have noticed that US largecap stocks seemed very expensive, but other equity asset classes did not seem so expensive.

In 1980s and 1990s, an international investor may have avoided Japan.

Weaker mispricings might be ignored.

I meant generally. Things could be actionable in extremes, but even then it is tricky. Many people who know tech stocks were over priced in the late 90s still badly misjudged the time to get out.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Rodc wrote:
I meant generally. Things could be actionable in extremes, but even then it is tricky. Many people who know tech stocks were over priced in the late 90s still badly misjudged the time to get out.

There is probably a difference though between noting that the PE of a sector is not sustainable (ie a valuation signal) and the timing (even in Smithers books, q is a signal, but it doesn't give you a great timing signal, the deviations from 'average' are so large and sustained-- that's my point about security returns looking fractal, the term 'average' may not help us much).

But with a bond your best estimate of return for holding that bond is the YTM. You are making a large assumption (that coupons can be reinvested at the same YTM-- except for a zero coupon bond) but as Bogle pointed out, it's a pretty good estimate of the return of holding a bond, even so.

Now you can't do that with a stock, or a REIT. The exit value is uncertain. However the majority of returns from holding REITs are held to be the dividends (more so than a stock) due to the payout structure-- making them unique amongst equity securities. So it's probably a *better* guide and the Gordon Growth Model probably works better there than it does for conventional stocks. (in fact practitioners tend to appeal to the Gordon Model mostly for mature sectors like utilities, rather than fast growing sectors like tech).

lazyday
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Valuethinker wrote:[snip]
So it's not easy to short because of an absence of securities or derivatives that let you do that and even if you do, you can get margin called.

However it's relatively easy to pick one housebuilder against another: the public information is all there, downloadable.

Thanks for the explanation, makes some sense. In hindsight should be obvious.

Forgetting classes without easy derivatives for the moment--I suppose works better for very different asset classes. For example, better explains an apparent mispricing between stocks and bonds, or even smallcap vs largecap, than midcap vs other size.

lazyday
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Rodc wrote:I meant generally. Things could be actionable in extremes, but even then it is tricky. Many people who know tech stocks were over priced in the late 90s still badly misjudged the time to get out.

Agreed.

Though in true extremes it seems uncecessary to get timing right. If one waits until an asset class seems obviously priced for poor returns, and swaps for another with acceptable expected returns (not posible in 2007 unless accepted bond returns) then one might suffer nasty tracking error for years as the overpriced asset becomes more expensive. The opportunity to rebalance from the expensive asset is reduced. But so is a kind of risk.

In the examples I mentioned (~1999 US, ~80’s Japan) even if early one would have helped the portfolio, provided an an extreme is waited for. And tracking error is endured while others buy mansions with margin funded dotcom riches.

I don’t know how representive those cases are. Studies have shown timing futile, but I wonder if such a strategy has been backtested. If it can properly be made methodical--estimating returns might be an art. With possible exceptions such as TIPS held to maturity, and some assets easier than others. (I suspect long nominal bonds may be more difficult to estimate than sometimes implied, but have little basis for this)

Swedroe has posted that [~1999] a time came when TIPS had higher expected returns than US stocks. By then one might have made some kind of change. Smallcap and small value, US and intl, also seemed far cheaper than US Lg.

hafius500
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

wbern wrote:...Dividend/earnings growth is a tad harder, but easy enough to derive from the NAREIT database; over the past 41 years, dividends have grown at 2.6% pa; unfortunately, inflation in the same period ran 4.2%, for negative real dividend growth of 1.6%...

Now I am confused:
NAREIT - Inflation Protection

From 1992 to 2011 "REIT dividend growth" outperformed the Consumer Price Index in every calendar year except 2002 and 2009.

Rental income is a source of inflation. If the earnings of REITs are linked to inflation, wouldn't we expect that dividend growth tracks the inflation rate (ignoring dilution)?
The NAREIT equity PRICE index underperformed CPI from 1971 to 2003 but it tracked the CPI from 1979 to 2002.

tpm871
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

To test my understanding, let me see if I can explain the underlying forces at work:

REITs represent physical assets that generate dividends (e.g., from rents on properties). The total dollar value of dividends paid out to all shareholders does not grow very rapidly. Since 90% of the profits are distributed to shareholders, there isn't a large amount of reinvestment by the REIT itself to grow its physical assets in order to grow future dividends. The total dollar value of dividends across all shareholders will tend to increase with inflation as rents increase, but isn't at all tied to the price of the REIT shares.

So, if the total dollar value of dividends paid out to all shareholders doesn't grow much, the yield per share will go down as a percentage of your investment as your investment gains in value. For example, let's say a REIT property originally generated \$50k in dividends to be distributed to its shareholders, and there were originally 100,000 shares priced at \$10 per share. If you bought 1,000 shares at this price, your investment would be worth \$10k and your yield would be 5% (\$500 in dividends per year). If the share price doubles to \$20, your investment would be worth \$20k, but your yield (assuming that the total dollar value of dividends paid out to all shareholders doesn't change much) would be roughly 2.5% (still about \$500 in dividends per year).

Lower yields are an indicator of higher REIT valuation, assuming that there weren't other factors suppressing yields (e.g., lower rents due to high vacancy rates). The lower yields make REITs a less attractive investment. So moving forward, the price appreciation will be modest. As interest rates rise, this will be especially true since there will be less of a spread between REIT yields and "safe" investments such as CDs or Treasurys; people would prefer the safe investments and demand for REITs would decrease. REIT prices will have to fall before the yields would increase, and there will be more pressure for this to happen as interest rates increase. However, high inflation would mitigate this a bit.

I'm not an expert, but this is my interpretation of what is being discussed in this thread. Does this sound right?

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

tpm871 wrote:To test my understanding, let me see if I can explain the underlying forces at work:

REITs represent physical assets that generate dividends (e.g., from rents on properties). The total dollar value of dividends paid out to all shareholders does not grow very rapidly. Since 90% of the profits are distributed to shareholders, there isn't a large amount of reinvestment by the REIT itself to grow its physical assets in order to grow future dividends. The total dollar value of dividends across all shareholders will tend to increase with inflation as rents increase, but isn't at all tied to the price of the REIT shares.

Except if you believe there is a 'normal' REIT yield. If you do, then there is reversion to the mean. That REIT yield is probably partly (or largely) set by larger capital market forces.

On dividend growth, you'd expect it to be a little faster than inflation *but* buildings depreciate and that requires a degree of reinvestment.

So, if the total dollar value of dividends paid out to all shareholders doesn't grow much, the yield per share will go down as a percentage of your investment as your investment gains in value. For example, let's say a REIT property originally generated \$50k in dividends to be distributed to its shareholders, and there were originally 100,000 shares priced at \$10 per share. If you bought 1,000 shares at this price, your investment would be worth \$10k and your yield would be 5% (\$500 in dividends per year). If the share price doubles to \$20, your investment would be worth \$20k, but your yield (assuming that the total dollar value of dividends paid out to all shareholders doesn't change much) would be roughly 2.5% (still about \$500 in dividends per year).

Yes that is correct.

Lower yields are an indicator of higher REIT valuation, assuming that there weren't other factors suppressing yields (e.g., lower rents due to high vacancy rates). The lower yields make REITs a less attractive investment. So moving forward, the price appreciation will be modest. As interest rates rise, this will be especially true since there will be less of a spread between REIT yields and "safe" investments such as CDs or Treasurys; people would prefer the safe investments and demand for REITs would decrease. REIT prices will have to fall before the yields would increase, and there will be more pressure for this to happen as interest rates increase. However, high inflation would mitigate this a bit.

That we don't know. It's a logical story, but you could also argue that since the yield on *all* assets are compressed, REITs won't be particularly disfavoured.

You could argue, on the basis of the random walk, that REIT yields are just as likely to be 1% in the future, as 5%, or 3%.

I'm not an expert, but this is my interpretation of what is being discussed in this thread. Does this sound right?

Fine.

If you go back to the Gordon growth model and the 3 terms.

- current yield we know
- future dividend growth we have to estimate, what Dr. Bernstein highlighted was that it has not been as great as we might have expected
- speculative return (ie the change in the yield)

Our discussion is about whether you can make a reasonable estimate for speculative return.

swaption
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Alright, going to bring this full circle a bit, and perhaps to the relief of those following along avoiding any discussion of the speculative return.

From an earlier post in this thread a couple of weeks ago, the below summarizes my thoughts to address Dr. Bernstein's assertion that REIT dividends should not be expected to grow faster than inflation because virtually all earnings need to be paid out in the form of dividends:

But briefly about what can be done with that retained depreciation. Presumably a building will need some capital improvements over time. To the extent possible, and assuming there is some latitude here, I would expect REIT owners to try and expense as much of those capital expenditures as possible and avoid capitalizing in the value of the asset. Once again this is just an accounting consideration, but as we have seen expensing allows the owner of the REIT to retain more for further reinvestment, thereby reducing the need to raise more capital.

In summary, I stand by my assertion that there is no fundamental basis to expect REIT dividend growth at a level below inflation. A REIT should very much be able to grow dividend distributions at a rate at least equal to inflation. The dividend distribution requirements should not alter this analysis. First of all, it is a real asset. Value, revenue, expenses, and cash flow should track inflation. Further, accounting depreciation should be available to reinvest in the business without the need to raise additional capital.

Now today I see an article debating various issues related to Data Center REIT accounting. As a result I came across the following research commentary:

The analyst explains: "We find on average that the ratio of recurring capex to annual depreciation REITs typically ranges between 15% and 20%, although Data Center REITs are much lower at 5%. This indicates to us that annual depreciation is often a poor proxy for recurring capex at REITs. This is because the true economic lives of real estate is often much longer than the useful life used for GAAP purposes to calculate depreciation. In addition, the economic lives of these assets are often prolonged through repairs & maintenance which ranges between 15-35% of total operating expenses for REITs but typically 40-55% for the Data Center REITs.

Appears to confirm my assertion that depreciation should be expected to be well beyond what would be required to maintain the economic value of the asset. As a result, the surplus depreciation would represent cash flow above and beyond earnings, which would be available for capital investment, thereby supporting earnings growth without the need to dilute equity through share issuance.

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

lazyday wrote:
Valuethinker wrote:[snip]
So it's not easy to short because of an absence of securities or derivatives that let you do that and even if you do, you can get margin called.

However it's relatively easy to pick one housebuilder against another: the public information is all there, downloadable.

Thanks for the explanation, makes some sense. In hindsight should be obvious.

Forgetting classes without easy derivatives for the moment--I suppose works better for very different asset classes. For example, better explains an apparent mispricing between stocks and bonds, or even smallcap vs largecap, than midcap vs other size.

Indeed so.

It's hard to trade against the whole dotcom bubble: roughly 1/3rd of S&P500 was Tech Media Telecoms.

Harder still to trade against an overvalued currency, say. Or the entire US housing market (3 times the value of the US stock market? Not sure) say.

Michael Burry, Steve Eisman-- in The Big Short they found ways. But even they nearly had the rug pulled out from under them.

Valuethinker
Posts: 27095
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

tpm871 wrote:To test my understanding, let me see if I can explain the underlying forces at work:

REITs represent physical assets that generate dividends (e.g., from rents on properties). The total dollar value of dividends paid out to all shareholders does not grow very rapidly. Since 90% of the profits are distributed to shareholders, there isn't a large amount of reinvestment by the REIT itself to grow its physical assets in order to grow future dividends. The total dollar value of dividends across all shareholders will tend to increase with inflation as rents increase, but isn't at all tied to the price of the REIT shares.

So, if the total dollar value of dividends paid out to all shareholders doesn't grow much, the yield per share will go down as a percentage of your investment as your investment gains in value. For example, let's say a REIT property originally generated \$50k in dividends to be distributed to its shareholders, and there were originally 100,000 shares priced at \$10 per share. If you bought 1,000 shares at this price, your investment would be worth \$10k and your yield would be 5% (\$500 in dividends per year). If the share price doubles to \$20, your investment would be worth \$20k, but your yield (assuming that the total dollar value of dividends paid out to all shareholders doesn't change much) would be roughly 2.5% (still about \$500 in dividends per year).

Lower yields are an indicator of higher REIT valuation, assuming that there weren't other factors suppressing yields (e.g., lower rents due to high vacancy rates). The lower yields make REITs a less attractive investment. So moving forward, the price appreciation will be modest. As interest rates rise, this will be especially true since there will be less of a spread between REIT yields and "safe" investments such as CDs or Treasurys; people would prefer the safe investments and demand for REITs would decrease. REIT prices will have to fall before the yields would increase, and there will be more pressure for this to happen as interest rates increase. However, high inflation would mitigate this a bit.

I'm not an expert, but this is my interpretation of what is being discussed in this thread. Does this sound right?

Just one clarification

'yield' (UK) or 'cap rate' (US) is net operating income/ value of property. When we talk about CRE as a sector, we talk about what yields people are paying for buildings (ie lower yield-- more expensive, usually a better location with a better tenant).

IN the long run, returns from investing in CRE are driven by the yields on the properties owned (the net rental income). You may or may not also get profits from the sale of buildings.

On REITS, REITS are stocks. Stocks have a dividend yield which = dividend/ price. Then the Gordon growth formula comes into play, in estimating the expected returns from a stock. In the case of REITs this is particularly relevant, because they pay out virtually all their US GAAP earnings (profits) whereas most companies retain a lot of their EPS, don't pay it out as DPS, and reinvest it in the business.

That formula = current dividend yield + dividend growth +/- speculative return

It's the valuation the market places on REITs (the speculative return) that we have been debating. In a normal stock, that's measured by the PE (higher is higher valuation) and in REITs, it's measured by D/P (ie lower is a higher valuation). Since DPS is almost equal to EPS in a REIT, they are the same measure, basically.

Questions about the valuation and rental from RE really come at a level below the question of valuation of REITs. In the very long run the two should converge but there are a number of additional factors in REITs: leverage, management fees, and the discount or premium to NAV the market places on them.

It's like saying Apple has a stock price, and Apple makes computers. Yes in the long run how well Apple does at the latter has a big impact on the former. But the stock price moves around for all sorts of reasons that are not to do with the health of the PC and ipad markets.

What William Bernstein is saying is that given where we are starting in yield, and historic dividend growth, REITs don't look wildly attractive. Unless you think the DY of REITs can go from 3% now (say 6% historic) to say 1.5%-- that would give you positive speculative return. Whereas if it went back to 6%, that would give you negative return.

The question of likely dividend growth is shaped by what happens to GDP and to cap rates (yields) on the underlying properties with the economic cycle.

Anti Illmanen notes that a factor influencing future returns from REITs seems to be where you start in terms of valuation (ie dividend yields).

Hastibe
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

richard wrote:
Leesbro63 wrote:Dr Bernstein, your stuff is great, but takes me a while to figure out what you are saying, can you summarize your point about why REITS may be "mispriced"?

He's not saying they are mispriced. He's saying given history, if you start with a yield of 3% your return won't be very good. Look at the chart.

Does this mean, then, that international REIT funds (the Vanguard one has a dividend yield of 17%) might be a much better investment right now?

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Hastibe wrote:
richard wrote:
Leesbro63 wrote:Dr Bernstein, your stuff is great, but takes me a while to figure out what you are saying, can you summarize your point about why REITS may be "mispriced"?

He's not saying they are mispriced. He's saying given history, if you start with a yield of 3% your return won't be very good. Look at the chart.

Does this mean, then, that international REIT funds (the Vanguard one has a dividend yield of 17%) might be a much better investment right now?

Can you source that 17%? It sounds like an anomaly, or a misprint.

Larry Swedroe has pointed out that on a price to cash flow basis, international real estate stocks are cheap relative to US ones.

There is an issue:

- REITs are a relatively new form in many markets. The international REIT index is heavily weighted to a few countries like Australia, UK
- many international RE stocks are really Real Estate Operating Companies (REOCs) ie normal companies that buy and sell RE, not REITs

DFA has an international REIT fund (about 66% USA) which is a much better proxy of the international REIT sector

I would say, assuming you can handle the tax issues (there may be some for a US investor, I don't know), that it's not a bad thing to be up to 50% in international RE stocks (including REITs) eg via the VG fund.

Hastibe
Posts: 181
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Valuethinker wrote:Can you source that 17%? It sounds like an anomaly, or a misprint.

The dividend amount is from the TD Ameritrade ETF Profile for VNQI, which lists the "Ann. Dividend/Yield" as "\$9.34/16.93%." Maybe I'm misinterpreting what this means, though? Please do let me know!

cheapskate
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Valuethinker wrote:Can you source that 17%? It sounds like an anomaly, or a misprint.

The dividend amount is from the TD Ameritrade ETF Profile for VNQI, which lists the "Ann. Dividend/Yield" as "\$9.34/16.93%." Maybe I'm misinterpreting what this means, though? Please do let me know!

IIRC, yield for both the DFA and the Vanguard Intl Reit funds is in the 5.something% range.

Also the DFA Intl REIT (DFITX) is nearly 100% Intl, not 66% US as VT mentioned, he was probably referring to the DFA Global REIT offering.

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

Valuethinker wrote:Can you source that 17%? It sounds like an anomaly, or a misprint.

The dividend amount is from the TD Ameritrade ETF Profile for VNQI, which lists the "Ann. Dividend/Yield" as "\$9.34/16.93%." Maybe I'm misinterpreting what this means, though? Please do let me know!

I assume that is some kind of distribution of capital? Because the Distribution Yield just next to it is more accurate-- something around 4.5-5.0% is what it would yield.

Valuethinker
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

cheapskate wrote:

Valuethinker wrote:Can you source that 17%? It sounds like an anomaly, or a misprint.

The dividend amount is from the TD Ameritrade ETF Profile for VNQI, which lists the "Ann. Dividend/Yield" as "\$9.34/16.93%." Maybe I'm misinterpreting what this means, though? Please do let me know!

IIRC, yield for both the DFA and the Vanguard Intl Reit funds is in the 5.something% range.

Also the DFA Intl REIT (DFITX) is nearly 100% Intl, not 66% US as VT mentioned, he was probably referring to the DFA Global REIT offering.

Sorry yes I suspect that is the mistake I have made.

A US investor could do something like 60% US 40% international and proxy it.

papito23
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Location: midwest

### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

So far, so good...

Vanguard REIT vs. Total US Stock, May 8 marks the start of this thread.

FTR I rebalanced into REITS June 3.
A thing is right when it tends to preserve the integrity, stability, and beauty of the biotic community. It is wrong when it tends otherwise. -Aldo Leopold's Golden Rule of Ecology

zaboomafoozarg
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

papito23 wrote:So far, so good...

Diversification is always working. Sometimes you'll like the results, sometimes you won't!

InvestorNewb
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### Re: How Would Mr. Bogle Calculate Expected REIT Returns?

According to Google Finance, REITs are down 8.36% from May 20th, 2013 to Today. It seems that they're making a small come back again.

I wonder if we're passed the dark cloud that was alluded to in the original post.
My Portfolio: VTI [US], VXUS [Int'l], VNQ [REIT], VCE [Canada] (largest to smallest)