The Not-So-Hidden Risks in REITs

March 31, 2015

by Keith Jurow

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With most investors confident that equity REITs are a sure bet to continue their upward momentum, now is an excellent time to carefully examine whether this ebullience is justified. Let’s see what the conditions in the real-estate market mean for valuations in several of the largest REITs, as well as two of the ETFs that holds them – IYR and VNQ.

As 2015 opened, bullish euphoria about commercial real estate reached historic dimensions.  In March of this year, Marcus & Millichap published the results of its latest Investor Sentiment Survey.

REITs

The Investor Sentiment Index evidenced record levels of optimism, well above the level reached during the pre-crisis bubble years.  The survey participants included both private and public investors with an average commercial real estate portfolio of more than $35 million.  Nearly 70% of those surveyed planned to add commercial real estate to their portfolios while a mere 6% intended to cut back.

There is plenty of other evidence showing that very wealthy investors have been sucked into this real estate euphoria.  TIGER 21 is a membership organization for ultra-high net worth investors.  It publishes a quarterly report showing the average asset allocation for all members.  The latest report covering the period through the end of 2014 illustrates how this asset allocation has changed since 2007.

REITs

Source: Tiger 21

You can see that the portion of assets allocated to real estate – 27% — exceeds the 25% of the bubble peak year of 2007.

Investors are now especially enthusiastic about REITs.  Who can blame them?  Take a look at the amazing performance of equity REIT stocks by sector last year.

REITs

Let’s look at the equity REIT bubble and collapse of 2007-2010, and then turn to the valuations of some of the largest REITs and the ETFs that own them.

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