Referenced Stocks:AVB;BFS;BX;BXP;CPT;HST;JNJ;KMB;LHO;NLY;O;PCL;PPS;PSA;RYN;SKT;SPG;TCO;VNO;YSI
I've always disliked the REIT (real estate investment trust)
structure in the belief that it forces a company to operate in a
highly unnatural way. Mandatory cash distributions forces most
REITs to constantly access capital markets. They seem to be in a
constant search for cash. In any case, REITs frequently end up
over-leveraged, at least to my liking.
The REIT structure is an arbitrary construction of the tax code
that provides favorable dividend treatment in exchange for meeting
certain obligations. Chief among these is that a company must
distribute at least 90% of taxable income to shareholders.
These constraints cause me to be a REIT skeptic at best. So weigh
the following thoughts accordingly.
Nonetheless, it's amazing how quickly a hefty dividend warms my
cold, dead capitalist heart. The trouble is, I am (just) old enough
to remember when yields of 12 to 15 percent were easy to find in
the REIT universe. Such yields are NOT ancient history. Think
Internet Bubble days, without "Flip That House" shows on HGTV. Real
estate wasn't virtual and, therefore, nobody cared. Not
coincidentally, it was a great time to buy REITs.
At the time, high yields were said to compensate investors for the
considerable risks they bore. Sounded reasonable to me. With
interest rates in constant free fall for the last 10 years, REIT
yields have fallen as well. Today's buyers argue that REIT yields
are still relatively attractive. The key word here is "relatively".
It can be a thoroughly dangerous word.
Call me crazy, but at some point absolute levels matter.
REITs have been pursued by yield-seeking investors searching for
alternatives in a near zero interest rate world. At some point, any
positive yield starts to look good. Relatively speaking. In the
case of REITs, this buying has now driven yields to ridiculous
levels. Absolutely speaking.
Frankly, REIT yields may look good compared to [blank], but it is
an apples to oranges comparison in many cases. REITs are
essentially a pass-through vehicle. Is a 3% yield on a REIT the
same as a 3% yield on Johnson & Johnson (
JNJ
) or Kimberly-Clark (
KMB
)? Since by law the REIT yield represents at least 90% of taxable
income, the answer is "no".
In any case, current REIT yields don't look sufficient to
compensate investors for the risks being assumed. In short there is
no margin of safety.
Given the nature of real estate, is a 6 percent yield enough? How
about 3%?
Excluding the mortgage REITs, like Annaly (
NLY
), double digit yields within the REIT universe are nearly
impossible to find. Even 8% is rare! Conversely, yields of 2 to 4
percent are abundant. Apparently investors must believe that
minuscule retained earnings and appreciation of the underlying
assets will offset these pathetic current yields?
It's too great a leap for this investor, but it is clearly a
minority view.
Just look at mall operator Simon Property Group (
SPG
). Its 2.5% dividend yield would imply an earnings yield, cap rate,
or whatever for the whole company of less than 3%. Round up if you
want. Either way, precious little margin of safety exists. At best,
it seems like a very full price to pay for a collection of mall
properties. Or am I missing something? Is retail booming? Mall
retailers in particular? You'd think so given SPG's valuation.
Sorry, but I can't suspend my disbelief. Our local mall (a Simon
property) is a ghost town. Maybe all the rest are thriving. They
better be.
Look through the whole collection of retail REITs from factory
outlets to strip malls and it's the same story. Whether it's
Taubman (
TCO
), Tanger Factory Outlet Centers (
SKT
), Realty Income (
O
), or even Saul Centers (
BFS
), you're lucky to break 4 percent for current yield or even total
earnings yield. Been shopping lately? Was there a line?
In a time of belt-tightening and sacrifice, one could imagine that
self storage would be a tough sell. Not so based on the price of
REITs like Public Storage (
PSA
) or U-Stor-It (
YSI
). Crazy multiples and tiny yields are the order of the day.
Did we have a real estate correction in this country?
Not if the apartment REITs are any indication. AvalonBay (
AVB
), Camden Property Trust (
CPT
), and Post Properties (
PPS
) - to name a few - are all trading within shouting distance of
their 52-week highs and yield around 3 percent. Hold me back!
I know... everyone who's lost their house is now paying full bore
to live in a luxury apartment owned by one of these guys, right?!
Sure. And 10% unemployment isn't hurting them either? Not based on
these numbers. Was my complex the only one with empty apartments
and residents behind on their rent? Apparently.
From office REITs - like Boston Properties (
BXP
) to hotel REITs - like LaSalle Hotel Properties (
LHO
) and Host Hotels (
HST
), everything must be booming. The valuations say so. But where is
the downside protection? Have you spoken to a commercial realtor or
a hotel operator lately? Investors in these companies clearly
haven't! Such disconnects scare me.
The lumber REITs like Plum Creek (
PCL
) and Rayonier (
RYN
) and their 4+ percent yields look positively cheap by comparison.
Lumber is in bull market mode. Did you know that? Even so, 4
percent? I grew up on a farm. Growing anything on the farm or in
the forest has risks. And these numbers just don't cut it.
Even Vornado (
VNO
), the king of diversified REITs has a pathetic 2.9% dividend yield
and is priced for perfection. So count me among the few who are
bearish on REITs in general.
Do we really need a reminder that real estate isn't riskless, that
the associated cash flows are not certain? Who's buying these
things? And at these prices?
It's not surprising that the
Bloomberg REIT index
topped out in early 2007 at around 300. If memory serves, it was
right about the time Blackstone (
BX
) bought Equity Office (EOP) from Sam Zell. 20 guesses who made out
on that deal?
Blackstone's purchase valued Equity Office at a low single digit
cap rate. How did their math work? After all, Blackstone used
mountains of borrowed money. No doubt the model hinged on future
growth, ever rising real estate prices, and a belief in the
Greater Fool Theory
. It's a formula that worked great in residential real estate! And
Blackstone found a few.
For Sam Zell, Blackstone was the only "fool" he needed. Two years
after the Equity Office deal closed, the aforementioned REIT index
was 80 percent lower. The concept of risk was reborn and Sam Zell
looked positively prescient. By March 2009, the index bottomed
around 70. And because the world didn't end as expected, it began
to rebound.
Today, the Bloomberg REIT index hovers around 170. Compared to 300,
this is relatively (that word again) cheap. Take comfort in this if
you wish, but 2007 represented a price bubble on top of a credit
bubble... a double bubble.
With many REITs currently trading near Equity Office-like
valuations, investors should be fearful of this sector.
Buying relatively cheap REITs could make you absolutely poor.
See also
Is Recession Risk Fading?
on seekingalpha.com
