REITs such as AVB and EQR are trading at historically high cash flow multiples and are paying out historically low dividends- unusually far below risk-free treasury yields even. If investors are willing to accept below-risk-free yields in a risky asset then they most surely are expecting cash flow growth. And when AVB pays only 2.3% vs. treasuries at 4.8% then we need a lot of growth in order to eventually match risk-free yields. Whereas in the past REITs have been viewed as defensive income-producing assets, they are priced far out of this now. Growth is their only justification. Thus its disturbing to see real signs of unsold housing now beginning to pressure rental rates since unsold units are being converted into rental units since their owners face significant losses if they sell now given the fall in housing prices.
We indeed were negative on apartment REITS back in November last year, and have since seen their share prices generally rise about 10%, with management touting a strong 2007 outlook in their conference calls yet selling shares worth millions of dollars concurrently. Avalon Bay recently took this practice to a larger scale- upping its 2007 outlook on January 8th and then immediately issuing 4.6 million more shares (on top of 74 million outstanding) for sale in the market. Convenient timing.
Private equity also did its fair share in pushing up REIT shares.
While the company mentioned above, Equity Office Properties (NYSE: EOP - News) is a commercial property REIT, and we are more negative on residential REITs, as stated above money pulled out of these shares frequently needs to go back into the market for investments with a REIT mandate and thus commercial REIT M&A can cause liquidity to spill into residential REITs such as AVB and EQR.
All in all we have to ask ourselves how much farther these REITs can go in 2007 after eight consecutive years of outperforming the S&P 500. For us to be wrong, vacant unsold housing mustn't pressure rents. We just can't see how this can happen. As in the New York Times article we first linked too, property owners who face selling prices significantly below their cost will shift to renting in order to try and make their investment back. While rents have done well recently, this was due to property being for-sale, and thus off the rental market. Get ready for it all to come back, for rental rates to stagnate, and for REIT prices to fall. It could be a long way down if investors demand that REITs return to their historical norm and require them to pay out dividend yields above treasuries.
Unequivocally agree with this. If you search you can find a few REIT's at 6-8% yields-----but you can find huge numbers of them at 2-3% yields----1 of 2 things have to (and we predict will happen) either the payout have to come way up or the prices will have to fall.
Of course as usual there is a question of timing--who knows. Overavalued assets can always get more overvalued.