The Dow Jones Real Estate Index peaked in February and is down about 20% since then. Because the stock market is a leading indicator and a similar peak in homebuilder shares in the Summer of 2005 coincided with the peak in home prices, this is good reason to think that commercial real estate has seen its best times for this cycle.
In an article from last Friday, “Commercial Real Esate Is Starting To Crack”, Steve Sjuggerud points out that the spread between treasury yields and REIT yields is now at it’s widest negative level ever: -1.76% – that is, Treasuries yield 1.76% more than REITS. He has a chart you have to look at that shows how when REITs yield much more than treasuries they do well and when the yield narrows or goes negative they do badly.
Whereas REITs were cheap, hated and starting to move up back in 2001 they are now expensive, loved and starting to move down. It’s time to get out of commercial real estate.
A recent Forbes cover story, “Shorting Skyscrapers”, profiled Jon Fosheim, one of the founders of the legendary REIT research company Green Street Advisors (Newport, CA). Fosheim, who made his mark investing in REITs left Green Street Advisors a few years ago to form a hedge fund and is now shorting REITs. When someone whose name is synonymous with REIT investing is betting against them, it’s worth paying attention to.
Fosheim argues that REITs have gotten too expensive. They are now trading at P/FFO (Funds From Operations) of 25 – compared to the S&P’s 17. REIT bulls argue that these companies are supported by the asset values of their underlying real estate. Fosheim counters: “Who says NAVS [Net Asset Values] can’t go down?”
Two big REIT acquisitions by private equity firms flush with cash also give reason to suspect we’re at a top in commercial real estate: Blackstone’s $23 billion (plus the assumption of $16 billion in debt) acquisition of Equity Office Properties after a bidding war with Vornado which closed in early February (subscription required), and the acqusition of apartment REIT Archstone Smith for $15.2 billion (plus the assumption of $6.5 billion in debt) at the end of May (subscription required).
On Monday, The Wall Street Journal ran a “Head On The Street” column, “Can REITs Tower Again?” (subscription required), wondering if the sell-off the last 5 months hadn’t been too severe. The article profiled four blue chip REITs (Simon Property Group, Public Storage, Kimco and SLG) that might be good value now after coming down 20-25% off their peaks.
I don’t think so: all four look like good short candidates to me.