Is the bloom coming
off the REIT rose?
The sugar coating may be
coming off one of the sweetest parts of the stock market.
One of the few
consistently lucrative parts of the stock market over the past four
years has been an oft-overlooked investment REIT.
Real Estate Investment
Trusts - companies that own things such as apartments, offices and
shopping centers, and distribute almost all their income to
investors in the form of dividends - have jumped 63 percent overall
since the end of 1999. During that same period, the Dow Jones
Industrial Average has fallen 9 percent.
There's not much mystery
to it.
As most stocks sagged
during the bear market, real estate surged. And as market interest
rates - bond yields, money-market rates - fell to their lowest
levels in 45 years, investors looked for other ways to generate
steady dividend income.
REITs on average have
yielded about 7 percent historically. With real estate booming, they
were the place to be.
Now, some investors fear
those glory years have just ended.
Monday of last week, the
Dow Jones REIT index fell 4.1 percent. Tuesday, it fell another 3.8
percent, marking the two sharpest daily declines since the index was
created 12 years ago. Overall last week, the REIT index fell 8
percent, while the Dow industrials were almost flat on the four-day
week, declining 28.56 points, or three-tenths of 1 percent, to
10,442.03. Markets were closed for Good Friday.
Why the sudden REIT
problem?
The declines follow news
early this month of surprisingly strong March job gains. That stoked
concerns that a surging economy could spark inflationary pressures.
Such an environment usually leads to higher interest rates. If rates
rise, many investors believe dividend plays such as REITs will
become yesterday's hot item.
"If you look at the
chart on this thing, it is pretty dramatic," said Jack Ablin, chief
investment officer at Chicago money-management firm Harris Trust,
who has been warning that REITs have taken on some characteristics
of an investing bubble.
Some investors worry
about trouble at other investments that also have benefited from low
interest rates - utility companies, brokerage firms, banks, home
builders and concerns such as General Electric, Ford Motor and
General Motors that have big financing arms.
Many on Wall Street
shrug off those worries. They believe REITs and other rate-sensitive
investments already have overreacted.
Merrill Lynch, for
example, published a report last week urging investors to use sharp
declines as an opportunity to buy REITs that specialize in
health-care properties such as nursing homes.
REIT fans note that the
Federal Reserve isn't likely to raise interest rates all that
rapidly, meaning that REIT dividends could remain much higher than
market yields for some time.
But there is a second
problem, and it has to do with the size of the overall REIT market.
In a U.S. stock market whose current value is more than $13
trillion, REITs taken together have a market value of around $210
billion, said David Shulman, senior REIT analyst at New York
brokerage firm Lehman Brothers.
That is less than 2
percent of the stock market. It is less than the market value of
General Electric - or Microsoft or Exxon Mobil.
So when investors began
chasing REITs a few years ago, there were a limited number of REITs
to chase. As investors' dollars poured in, REIT values soared to
records, leading people such as Ablin and Shulman to begin warning
of a bubble.
"REITs peaked on April
Fools' Day, which is a little joke we have around here," Shulman
said. "These stocks were trading at all-time highs. They were up for
14 straight months without a correction. They were trading at 135
percent of net asset value," based on the overall appraised value of
the assets that they own.
Their prices were 13
times their income from operations, also a record, he said. Prices
got so high that their average yield - their dividend divided by
their price - fell below 6 percent.
When an asset is that
stretched, it takes only a small blemish to cause a problem for
marginal investors. That is why REITs fell so sharply at the start
of last week, on the fear that market yields are due to rise now.
Similar worries last
week hit other sectors. Investors have begun wringing their hands
about what they call the "carry trade," or the strategy of borrowing
money at low short-term rates and investing it at higher long-term
rates. That works fine until short-term rates rise, when it can turn
into a vise.
Many financial companies
have used that strategy. An investment institution can borrow
short-term for 3 percent or less and get a yield from an REIT of 6
percent or more. A bank can borrow for as little as 1 percent
overnight and then lend at 5 percent or more longer-term.
It sounds like a
no-brainer. But when short-term rates go up, the cost of funding a
longer-term investment rises, and the income from the longer-term
investment stays the same - or even falls, if the value of the
longer-term asset declines.
A brokerage firm or
money manager investing in long-term mortgages, a bank that has
issued long-term loans, or an individual who owns REITs finds his or
her profit margin shrinking.
Investors generally
don't wait and react after a problem blossoms; they react as soon as
they get a whiff.
That helps explain not
only why people have begun moving out of REITs but also why there
has been erosion in junk bonds and in the stocks of companies such
as banks, brokerage firms and money-management firms that have used
the carry trade. |
