Watch Out For REITs!
Posted On Wednesday, January 19, 2011 at at 2:02 PM by Finance FanaticMarkets struggled to gain ground today as there were a lot of selling pressure throughout the entire day. Despite the down day, for most of January, thus far, we have seen this continual uptrend in markets, which is continuing to surprise me. At this point, I do not know how much longer it will last, but chart trends are definitely showing a slowing in momentum.
Commercial REITs have enjoyed record stock gains this past year. Those that were willing to roll the dice on them a year and a half ago have been rewarded significantly. At one point, there were many analysts who did not think any would survive the storm at the end of the day. However, this past year, from a stock price perspective, they have rebounded significantly.
My worry is what is driving this? Sure, lending markets have softened up a bit after being completely frozen for a year and a half. However, with exception to single family and multi-family financing (thank you Fannie and Freddie), good commercial loans are difficult to come by.
I am a professional in the real estate market and it is quite the paradox that we are seeing in today's market. Properties are trading, but in abnormal rates. Valuation spreads have become huge depending on property type and market density. All the major big buyers out there right now are... Wall Street (REITS). You know why? Because they are the only ones crazy enough to be buying at the prices they are offering.
I am amazed at what large portfolios have closed at what price, when looking at a variety of recent closings. When looking at the buyers pool, there is a clear separation of where the REITs are coming in at and where the private investors are. So why the gap?
REITs have the luxury of using other people's money. Much of their administration fees are made by doing actual transactions. In many times, these funds have deadlines in which funds need to be placed, or they will lose the funds. When that loss of funds can amount to millions in lost fees on behalf of the fund, you better believe that money will be placed. This is why, especially in more primary markets, you will see REITs offering 2007 prices for real estate today. Fundamentally, it doesn't make sense.
Unfortunately, many people investing in REITs are ignorant to what is happening and just want a chunk of their portfolio to be in real estate. REITs are the best option then right? I don't have the risk and responsibility for owning and managing a property, but I have equity in the upside. That's if there is upside. Many people are fooled into thinking that an increasing REIT stock price directly reflects the quality and value of their holdings. This is not the case. The stock price is relative to the demand of investors. It is hard to link that action to fundamental valuation.
As of now, it seems to be working for REITs, as there has been a big shift into real estate the past few months, as many investors are wanting to diversify a bit more out of equity markets due to fear of a near pullback. As a result, REITs have cash and they are spending it. The big question is are they sustainable or is it another Ponzi scheme? Mark my words, we have not seen the end to sunken REITs.
This is not to say that there are no legitimate REITs out there. Not at all. Just keep in mind that just because they have a rising stock price, this is not reflective of their real estate performance. In fact, many have had to slash dividends from around 5% to 1%. That definitely changes your return on investment. When buying into REITs, look up their recent transactions. Verify that they are not just maximizing volume as to make their managers rich. There are good deals out there, just not too many at this point. Do your due diligence before making a decision. Happy Trading.