Posted by Don Martin on Fri, Aug 12, 2011 @ 08:54 AM
Should investors buy REIT’s when interest rates are low?
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Low interest rates can act as a lever to enable investors to buy assets during a recession. Low interest rates can help to start a stock market or real estate market boom. So it is tempting to think that this is the time to buy a REIT, but that is wrong. The ideal time to buy assets is not when financing is chap, rather one should buy when financing is expensive because then the price will have been reduced because higher interest rates make assets less affordable. The Fed’s low interest rates are short term and are not locked in and are specially designed to lure investors and business into taking risks and expanding their assets. But as soon as the economy recovers then the Fed will raise rates, thus hurting valuations of real estate. So an era of low rates can be a debt/deflation trap which is like a “value trap” for stock investors who misdiagnose low prices and high dividend yields as bargain when it is really a tip off that a crash is coming.
Are you getting paid enough?
The decision to buy a REIT should be made by assuming that a REIT has no debt and then analyzing the cash flow to see what the yield is after all expenses. Of course you would need to analyze it with the interest expense as well, but for clarity an investor in real estate needs to see what is the return if the asset had no debt service. If a REIT can’t provide a yield as good as a long term maturity BB or BBB bond (using a long term average of interest rates instead of today’s low rates) then it is overpriced. It is necessary to also see if the REIT is well managed with no deferred maintenance and proper depreciation. The median PE ratio for mutual funds that invest in real estate companies was 39.7, which implies a 2.5% earnings yield.
Offering rental property for rent is simply another service that can suffer from a lack of demand. During hard times consumers and business reduce the amount of real estate that they occupy, or move to a lesser quality property, work from home, etc.
I have written “Are REITs a good investment?”
Investors should seek independent financial advice.
Posted by Don Martin on Mon, Jul 11, 2011 @ 03:34 PM
Do REIT’s protect investors from inflation?
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Some people think a strategy for hedging against the risk of inflation is to buy a REIT. My opinion is that inflation may not come for a long time and that it may take many years for the U.S. to get out of a Japan-style Soft Depression. Further, if inflation returns it would be an inflationary depression where people have less purchasing power in real terms and must cut back on purchases, including moving towards leasing smaller offices, smaller apartments, etc. Employers could continue the process of moving jobs to low cost suburbs, using “hoteling” for employee office space and encouraging employees to work from home thus freeing up office space. It is a myth that real estate becomes scarce “because they are not making any more of it” because there are ways that office and residential tenants can save money by reducing consumption of square feet of real estate and the quality of their standard of living.
The search for higher yields than offered by bonds may have made investors overpay for REIT’s and thus REIT’s would not be a good investment.
Could this be the returns from REIT's?
What makes real estate go up is not inflation but rather it is a long period of low inflation and low interest rates coupled with rising income which increase demand for more and better quality real estate. Society has been experiencing a long history of shrinking or stagnant real income going back as far as 1998, so this is time for consumers to cut down on the consumption of real estate by moving into smaller leaseholds.
Assuming that inflation returns then interest rates will rise which will hurt the ability of people to buy real estate, thus making it go down.
My forecast is for a moderate deflation so that inflation won’t be a problem and instead investors will find they have panicked and overpaid for potential inflation hedges. Commodities, etc. will go down in price as they did when Lehman collapsed in 2008. It is important in investing to wait patiently to buy investments at a discounted price and to avoid overpaying for investments.
I wrote a blog post “Inflation creation machine is broken” and “Contrarian view of inflation”.
Investors should seek independent financial advice.