Interest Rate Roundup

Monday, November 27, 2006

REIT rout

I wondered out loud the other day about whether Sam Zell's deal to sell Equity Office Properties to private equity buyer Blackstone Group was the mother of all bells signaling a top for REIT shares. Lo and behold, the iShares Dow Jones U.S. Real Estate Index Fund (IYR) closed down 2.59% today. That's the worst one-day percentage decline going all the way back to August 2005, and twice the decline in the Dow. Maybe investors are slowly regaining their sanity ... or maybe it's just a blip. You never know. What I BELIEVE, however, is that ...

* Real Estate Investment Trusts are wildly overvalued by a wide variety of measures (including price-to-earnings and price-to-Funds From Operations (FFO) ratios)

* A weaker economy will crimp rent growth in the office and retail markets. And in the apartment market, you have a very large (and growing) supply of "shadow rentals" from stuck house flippers who can't sell and are trying to rent instead. That will likely throttle down the rent growth we've seen at key apartment REITs.

* Lastly, REIT yields are far below what you can earn on risk-free Treasuries, much less other fixed income investments. The IYR has an indicated yield of a whopping 3.38%, for instance, versus 5.13% on a 6-month T-bill.

A gigantic flood of private equity/LBO money has sent share values higher across the sector. But maybe today's action shows that Sam Zell isn't the only smart investor looking for the exits.


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