Tags: REITs | overbought | sector | selection

WSJ: REIT Run-up Raises Bar on Sector Selection

By    |   Tuesday, 24 July 2012 09:33 AM

Real estate investment trusts (REITs) have been on a tear for the past 3 ½ years, pushing some sectors to what may be overbought levels.

That means investors who are ready to dive into REITs now should be careful about which industries they choose, The Wall Street Journal reports.

The FTSE NAREIT US Real Estate Index shows that REITs have produced a total return of 16.6 percent this year, far exceeding the 9.7 percent return of the Standard & Poor’s 500 Index. And total return for the REIT index bested that of the S&P 500 by an average of more than 6 percentage points a year in 2009-11.

As a result, REITs now stand at a 17 percent premium to their net asset values, compared to an average premium of 7 percent since 1994, according to J.P. Morgan Asset Management. Net asset value equals analysts’ estimated value of a REIT’s properties minus its debt.

REIT dividends still make them an attractive investment, experts say. REITs have an average yield of about 3.5 percent, and experts anticipate dividends will grow 4 to 6 percent over the next few years.

"Prices for REITs look safe, because cash flow for real estate has only recently started to grow again," J.P. Morgan strategist Michael Hudgins tells The Journal.

But some sectors may have soared too far for their own good. Apartment REITs represent a sterling example. The sector has soared, as many former and potential homeowners have opted for rentals instead.

The Morningstar residential REIT index has enjoyed an average annual return of 41 percent over the past three years. That kind of supercharged performance generally doesn’t last long. Experts say apartment REITs may be more than 20 percent overvalued.

Even Avalon Bay, perhaps the top name in the apartment space, is vulnerable, REIT aficionados say. Morningstar analyst Philip Martin puts the REIT’s fair value at $118. But it recently traded 25 percent above that level.

“We feel the share price premium reflects unsustainable long-term operating performance, growth assumptions and optimism,” he writes on Morningstar.com.

“[That’s] despite strong multifamily sector supply demand fundamentals, a still-struggling single-family housing market, competitive advantages associated with the Avalon Bay business model, and a very healthy balance sheet.”

With healthcare spending amounting to 19 percent of GDP and set to grow at 5.8 percent a year for the rest of the decade, healthcare REITs represent Martin’s favorite sector.

Healthcare REITs that receive strong accolades from analysts include Ventas, HCP, and Health Care REIT.

Some experts are bullish on industrial REITs, such as warehouses and distribution centers. “Demand is picking up, and they haven't yet gotten too popular with investors," Rich Anderson, an analyst with BMO Capital Markets, tells The Journal. He likes DCT Industrial Trust and Duke Realty.

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Tuesday, 24 July 2012 09:33 AM
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