I was just reading up on the coffeehouse portfolio, and introducing real estate into my long-term IRA portfolio seems like a good idea.
My problem is that REITs look way overvalued. I understand that because they are small/mid cap stocks, they are somewhat correlated with that market. But the PE ratios seem rather high, 39! And the PB ratio is 3.9. (This is from VGSIX - Vanguard's REIT index - but it seems to match the REITs that I checked.) Compare that with a small-cap index PE of 22 and PB of 2.4 - which itself seems somewhat overvalued.
Is there a rule of thumb for evaluating REITs?
Is there some other dead-simple way to introduce real estate into a portfolio without buying into a risky limited partnership or purchasing a rental property?
wrote With attention to holding REITs within an IRA with a long time to go before retirement:
Three parameters to which I think one should pay one's first attention with REITs are
--"Funds from Operations" (FFO). In fact, conventional wisdom for REITs is to use P/FFO completely in place of P/E.
-- Dividend payout ratio
-- Dividend history
The site
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is a resource for P/FFO that will at least introduce you to relative standings among REITs. Click on "REIT Performance Data," then "REIT Performance Data By Company," then "REIT Performance Information," then select a REIT. Google on {"funds from operations" evaluating REITs} and you will find some good discussions.
Try to get a feel for the different types of REITs available. The variation is pretty wide. I will not touch mortgage-based REITs, for one.
I agree with your concern about REITs being overvalued now. I have owned several REITs since about 2002, and their prices have all shot way up (that's luck, not skill on my part, AFAIC, though I did figure in the long run my collection of REITs would do fine). But I am at the point where I am selling some of the REITs and taking gains. Yields are way down on the type of REIT I buy (older, larger, intermediate yield). I do not know what the future holds, of course, but I am guided by valuations like yourself.
If you're new to REITs and determined to plunge in for the long term, I would stick with REIT mutual funds with low expense ratios.
Apart from owning one's own house, I think you've covered the major categories.
REITs held outside an IRA or other retirement vehicle promise a lot of fun at tax time, BTW. But one could be said to be a better woman/man for it. :-)
Another important metric to look at is how REITs are priced compared to comparable real estate NOT held in REITs. If REITs are undervalued relative to their assets, real estate investors are encouraged to take a REIT private and possibly sell off its assets piece by piece. The WSJ column on real estate often has comments on this measure of REIT valuation.
snipped-for-privacy@aol.com wrote in news:1168272193.933083.320760@
38g2000cwa.googlegroups.com:
Good point. It's also important for the OP to realize that you often get very diferent impressions of value when you look at the premium or discount to asset values versus looking at the cap rates in relation to competing investments such as stocks or bonds. Sadly for the OP neither look too hot right now.
My own rule of thumb is to look at discount/ (premium) to underlying assets.
At the bottom of the REIT slump in the US in the early-mid 90s this was as low as a 40% discount. It is now, I believe, at a typical 10% premium.
The logic is this. There are problems with the accounting for net assets in REITs-- historic cost accounting conventions don't track market value *however* it is also an audited 'clean' number. Other than dividend yield, it is as close as you can get to a 'real' number reflecting the true state of the underlying assets-- remembering you can now go to prison as a corporate officer for misstating it.
As far as I know, no. There has been an almost global boom in residential and commercial real estate investing, with many institutional and individual investors increasing their weightings in real estate. This has driven yields (and discounts) down to record lows. Even places where buildings were selling for less than replacement cost (Japan and Germany) are now experiencing investor-led rallies.
My own belief is that real estate is inherently cyclical: the key being the very long time lags in real estate between demand and supply (The Economist had a nice piece on skyscrapers: the completion of skyscrapers, especially the world's tallest ones, neatly times the top of each business cycle).
Most commercial real estate is also highly linked to the general economy: for example shopping malls often have sales performance-linked rents, office demand closely tracks the overall economic health, hotels are an early leading indicator of the business cycle (people travel less in bad times, and room yields fall).
It doesn't seem like a good time to be investing in real estate. I would be investing in distressed asset real estate investors, in anticipation of a turn in the cycle, however I don't know of any publicly available funds which do this.
David Swensen's 2 books (which are indispensable) have some good discussion of timing in real estate investing.
To follow valuation of REITs over time, go to Green Street Advisors, click on Free Research, then on Historical Data -- NAV Premiums and Discounts. The direct link is
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I recall vaguely that I learned this from the book by David Swenson, head of Yale's endowment.
[I suppose I'd have to subscribe to their monthly publication if I were to actively trade REITs. What I did read in the sample seemed straightforward - essentially buy low, sell high... and they'll do the research so you can do that.]
Is that in _Unconventional Success_ (for personal investors) or his earlier book for institutional investors?
Greenstreet shows whether _market sentiment_ has over- or -under-valued REITS relative to the NAV of their underlying assets. Remember that a the market price of a REIT varies about its NAV -- by quite a bit over time, as the Greenstreet plot shows. Right now, market price and NAV are about in line. If commercial real estate owned by REITS were in a bubble similar to that enjoyed by residential real estate until recently, NAVs might be high relative to some "long term real value." No way to measure that.
Yes, the Swenson book in question is Unconventional Success, aimed at individuals. Perhaps his major point is that individuals would be terminally foolish to try to emulate Yale.
Thanks. I think I understand the distinction now. It's subtle, for me, a comparative neophyte.
Something similar could occur if a closed-end fund were under- or over-valued as compared to the stocks it holds. But that doesn't say anything about the underlying stock value. There were a few paragraphs about finding this sort of opportunity with closed-end funds in _A Random Walk Down Wall Street_.
*except* remember NAV is historical, share prices reflect current expectations of the market.
I agree the chart doesn't argue that REITs are expensive in historic terms. However REIT yields are, I believe, as low as they have ever been (a function of a general fall in interest rates and market yields).
A major factor must be the 'take private' moves that are currently taking place. Even America's largest REITs are the subject of leveraged buyout attempts by US private equity houses. Now private equity is an area that it awash with cash, and struggling to find ways to deploy it. I believe this is, in turn, driving up the stock prices of REITs.
If there were to be any form of recession, if bond yields were to rise, or if worldwide investors were to slow or stop their rush into property, then I think commercial property would be vulnerable (although I accept that it looks much less overvalued than residential property in many markets). There isn't a case that REITs are 'cheap' to provide the 'margin of safety' in the investment.
I found it on page 69 in _Unconventional Success_. I'll also be sure not to invest in the Wells Private REIT - it's discussed next in the book. Talk about exorbitant fees!
I had held off reading the book due to the amazon reviews; they categorize it has a very difficult read. But so far it's a great read, although familiarity with personal finance terms and concepts IS needed.
It is not an easy read. But both it and the institutional investing one are goldmines of analysis and information about how to do it.
Most far thinking institutions swear by investment in timber. Hard to do as an individual (Plum Creek Timber being the most liquid vehicle) and it may have become too much of the fashion of the moment. But the long term record is fantastic (outperformed the SP500 with lower volatility). See also the GMO (Grantham Mayo Van Otterloo) website.
FWIW I think the Green Street advisers (thank you for the reference!) is really helpful. You can make money in REITs when they are trading at significant discounts to net assets (see also the Closed End Fund discount puzzle-- Burton Malkiel's 'Random Walk Down Wall Street' has a great chapter about this). When they are trading at par or a premium, you are not likely to make money (this regardless of prevailing interest rates or other macro factors).
Indispensable investing books:
- William Bernstein - 4 Pillars of Investment Wisdom (relatively light read) and the Intelligent Asset Allocator (relatively hard read)
- Belsky & Gilovich - Why Smart People Make Big Money Mistakes
- Swensen (both books)
- Burton Malkiel - A Random Walk Down Wall Street - a book no broker will ever recommend, which is indispensable
- John Bogle's books
-David Dreman - the New Contrarian Investor
I also like reading general books about financial markets such as:
- Edward Chancellor - Devil Take the Hindmost (a history of financial crashes)
- John Kenneth Galbraith - The Great Crash
- Where are the Customer's Yachts?
- Reminiscences of a Stock Operator
- Frank Partnoy: FIASCO and his later one (about financial fraud in the
90s)
- Adam Smith 'The Money Game' - about the stock markets in the mid 60s (which were very close to the late 90s)
- John Brooks 'The Go Go Years' (ditto)
- Maggie Mahar 'Bull' - history of the stock market 1982-2002
- the collected writings of Warren Buffet
One's main conclusions are that there is nothing new in financial markets.
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