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REIT

09/09/2010
Real Estate Investment Trusts (REITs) continue to outperform the S&P 500 Index.
 
Year-to-date, the MSCI US REIT Index is +18.49% and the DJ US Real Estate Index is +16.76%.  The IShares DJ US Real Estate exchange traded fund (IYR), which offers broad sector exposure, is +19.67% year-to-date.
 
In a low yield investment environment, an average dividend yield of 3.95% for the IYR will certainly garner the attention of money managers. However, the fundamental improvement in the sector during the second half of 2009, and the 2010 continuance, is also driving the outperformance. The obvious critical question becomes how sustainable are the fundamentals in an economic recovery that is late stage and slowing.
 
In the second half of 2009, the REIT recovery began with a surprising improvement in liquidity. On the desk at Fast Money we were collectively rather amazed at the sector's ability to raise capital. Heading into 2010, effective bottom line management and lower debt service extended the sector's recovery momentum with surprisingly strong earnings and guidance. Consolidated debt-to-asset ratios have fallen from 24 months ago, from 60% to now near 50%. Low interest rates will continue to provide a tailwind to the space.
 
Fundamentals still suggest market weight exposure to the space.  Looking forward, I suggest a focus on the following points:
 
    1. a reversal in the improving debt-to-asset ratios 
    2. a moderation in the improvement in vacancy rates that will reduce pricing power (see chart below) 
    3. a second act of U.S. quantitative easing - favorable condition for REITs = cap rate support 
    4. a focus on retail "mall owners" versus retail "strip owners"   
    5. a continued "L-recovery" in U.S. housing = positive apartment operator trends  
 
DJ US Real Estate Index Daily chart 6/08/09 to 09/03/10

Source: Bloomberg

IYR Weekly Chart with 200 week moving average 9/12/08 to 9/3/10


Soruce: Bloomberg

MSCI US REIT Index Daily chart 6/08/09 to 09/03/10

Source: Bloomberg
 
US Census Bureau quarterly rental vacancy rate

Source: Bloomberg

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