# Are REITs in a bubble?



## Freedom25 (Dec 3, 2011)

I sold my house in the summer, downsized to a small condo, and have money left over that I would like to invest. I'm thinking of a REIT- everyone tells me that they will be fine when the real estate bubble pops or deflates (whenever that finally happens... it's taking a while), but I don't understand why this would be.

I researched some REITs and the price curve of each one followed the same insane curve of the housing bubble, right down to the 2008 dip (although REITs dipped more than housing did) and subsequent recovery. Surely, when housing starts it's descent (slow or rapid is yet to be seen), the REITs will follow?

Am I wrong on this, that REITs will go down with housing? Would love to hear some opinions on why REITs are still safe investments, or why they aren't.


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## jamesbe (May 8, 2010)

Each sector is different IMO. Commercial doesn't seem as bubbly.


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## Berubeland (Sep 6, 2009)

I disagree, and I have stated so many times. I am very concerned with REITs as an investment.

1 - Building Values are intricately linked to interest rates which are at an all time low. 

2 - Cap Rates are also historically low, as are the margins. 

3 - When interest rates go up two things happen, building value goes down, profits go down. Commercial mortgages are not the happy happy joy joy securities that residential house mortgages are. It is not unusual to be told your mortgage will not be renewed and to find a new lender. 

4 - I was told by a very large broker who works for a pension fund that she has no idea what a lot of these REITs are claiming as their leverage. She processes their applications and a lot are leveraged to the max which is 75% but at current building valuations. These mortgages are in danger of getting cash calls and non renewal once rates go up. 

5 - I do not have the confidence that if the RE market crashes here investors will not pull out of any investment with Real Estate in the name. This is emotional reaction and that's what people are famous for.


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## CanadianCapitalist (Mar 31, 2009)

One further point: many REITs are trading at a significant premium to analyst estimates of NAV. It is not unusual for REITs to trade at a discount to NAVs, so in that sense one can consider them to be overvalued.


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## slacker (Mar 8, 2010)

I have a 10% exposure to Canadian REIT's. They seem very sensitive to interest rates. As long as interest rates stay low, REIT's will continue to do well. And no one can really guess when/if they're going up.


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## Potato (Apr 3, 2009)

I don't think they're something to look at buying right now, as they're all getting over-valued. But I also don't think they're in nearly as bad a position as residential real estate is -- I'd short a Vancouver or Toronto condo if a vehicle existed to let me do so, but I wouldn't be short the REITs.

Many of the big ones are yielding less than 6%, and 20 years out, that's about all the return I'd figure you're in for: maybe they'll drop if/when residential housing drops, spend a decade deleveraging, and climb back up for the next decade, or maybe they'll be boring and just pay out a steady stream of income, but either way IMHO that's not enough return for the risk of owning them. Especially when you can get 4-5% from owning their bonds.


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## Causalien (Apr 4, 2009)

Which begs the question.

Which one do you think can best survive the coming apocalypse? Which one is conservative enough.

Name your names and I will go over their books over Christmas at the fireplace.


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## leoc2 (Dec 28, 2010)

Causalien said:


> Which begs the question.
> 
> Which one do you think can best survive the coming apocalypse? Which one is conservative enough.
> 
> Name your names and I will go over their books over Christmas at the fireplace.


Can Santa bring me his report on BMO ETF REIT (ZRE)? I have been a good boy all year.


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## kcowan (Jul 1, 2010)

Freedom25 said:


> Am I wrong on this, that REITs will go down with housing? Would love to hear some opinions on why REITs are still safe investments, or why they aren't.


Stick with what your gut is telling you. It might not be right, but at least it will be comfortable.

(I am short real estate, insurance and banking. I have watched TD go from 48 to 72. But I can still sleep at night. I have also watched lower mainland RE go up double since I got out. Markets can be irrational for very long periods.)


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## Spidey (May 11, 2009)

REITs may be fully valued, but I don't think they are in a bubble. I've even been adding a couple of names over the last couple of months on dips (MRT.UN, D.UN and CAR.UN) You can look at each individual REIT and see how they look on a value basis by looking at debt, price to NAV, etc. I would think that many are currently, or will be securing longer term debt in this low-interest rate environment that will likely stay at these levels for the next two years. That being said, one of my most important criteria for this category is debt, as the ones with higher debt ratios will suffer the most if we get any interest rate increases. I've avoided REITs such as HR.UN for that reason.


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## Berubeland (Sep 6, 2009)

A while back I did an two part interview with Greg Romundt of Centurion REIT for Million Dollar Journey. Read the comments as he answers questions about REIT valuations and makes excellent distinctions. 

We all know what happens when a company lowers distributions. So probably best to avoid those companies that have unsustainable distributions. 

http://www.milliondollarjourney.com...nd-ceo-of-centurion-apartment-reit-part-i.htm

http://www.milliondollarjourney.com...d-ceo-of-centurion-apartment-reit-part-ii.htm


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## CanadianCapitalist (Mar 31, 2009)

Spidey said:


> REITs may be fully valued, but I don't think they are in a bubble.


I agree. RioCan for instance has a NAVPU (per TD Securities estimate) of $22.40. That's a premium of 15%, which is within historical range. That's hardly bubble territory.


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## Freedom25 (Dec 3, 2011)

Well, I guess my gut is telling me to wait a bit anyway. I don't think I'll really lose money by waiting- maybe a bit in the short run but if things do take a plunge it might be safer to hold off a bit. They have to plunge eventually, but then again, I've considered RE overvalued since around 2002! I'm amazed it's climbed so long and hasn't crashed, I got so lucky with my house timing (bought in 1999, sold 2011, almost tripled in price in 12 years). Thanks for all the feedback, it helps. I'll check out those articles tomorrow Berubeland, thanks- I'd read a couple of others you wrote I think when I was looking in the archives, they were helpful.


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## canadianbanks (Jun 5, 2009)

I wouldn't touch REITs at this point as both commercial and residential real estate are significantly overvalued in my opinion. I know that real estate will crash here in Canada as it has in many countries around the world, however it may take longer that anybody expects...


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## Cal (Jun 17, 2009)

I don't consider them to be in bubble territory. For the most part, not many great prices out there to buy at. For sure.


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## Eder (Feb 16, 2011)

I do know I am very happy to be 15% into reits...if not for them and telecoms the last year would have been pretty pathetic return wise.


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## Mall Guy (Sep 14, 2011)

I think you have to look beyond the name, and really look at what they own. Not sure I would touch any of the private REITs, and would stay away from the the smaller names (BTB.UN or TR.UN) as well. But CAR.UN and NPR.UN tap into CMHC financing, and CWT.UN (the "Walmart REIT") has long term leases in place. There are a few that concentrate on grocery anchored properties (food + drug + liquor stores and banks) - like FCR - (a REOC that acts like a REIT) for instances. 

Several REITs have good management/shareholder alignment where a single unit holder owns a significant block of equity (HR.UN, CWT.UN, FCR, CRR.UN). CREIT (REF.UN) has a very conservative payout ratio, a great long term chart (15% CAGR over the last 17 years) and a current 4% yield. 

The spread between CAP and mortgage rates is still pretty much where it has historically been (ie 2% +/-). When interest rates were 8-10%, cap rates were 10-12%. Cap rates for "A" properties are currently 6-7% and interest rates are 4-5%. Look for a REIT that matches their lease and mortgage terms. 

Can't remember if Hotels are a leading or lagging indicator, but INN.UN seems to have taken on the chin lately. Just saying that the REIT universe is very diverse in terms of quality, management and investment philosophy. Stick with the quality names.


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## kcowan (Jul 1, 2010)

Won't the crisis in residential property eventually spill over into commercial deals?


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## Berubeland (Sep 6, 2009)

I believe it will in two ways...

1 - Investor confidence in the asset class. By and large most people are used to real estate going up and up. Most investors are emotional rather than logical. If residential real estate crashes, real estate assets a whole will become unpopular. No one will care that it's hotels or office buildings, they will shy away. 

2 -Real estate is such a fundamental driver to our economy (up to 20%) the entire economy will stumble and falter and this will have an effect on malls and office buildings that in each REIT. Now some people would say well those places have leases...which is true but...if the tenants can't pay the rent and close down, they won't pay rent. Most of those owners are personally liable...so if they have money they can be collected from, but it's not easy. 

3 - Financing tightening will have a large effect on commercial lending. In 2008 when the US crashed, large commercial projects such as one of the Sherway Towers in Etobicoke were unable to get financing. These projects were sold out. Usually these projects are financed by several lenders, but in this case they were unable to come up with lenders who would lend more than 5-10 million each. They would have needed to get 20 or so lenders to get together to complete the building. They failed. 

You'll have some serious financing issues with lenders not wanting to lend. Now lenders in commercial property will not be lending on some of these loosy goosey numbers they've been accepting. They will also be asking for larger down payments and higher returns on the projects they lend on. 

For all these reasons...I'm out


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## Freedom25 (Dec 3, 2011)

That's what I'm worried about too, Berubeland. From my research, REITs should be somewhat separate from a housing price crash, but they won't be due to the hit the economy will take, and then they will be hit harder than they should be due to the emotional factor. I really want to buy some, so I wish the housing market would hurry up and deflate (not that I am wishing doom and gloom upon us, but real estate is overinflated and has been for years, so lets get it over with so that normal safer times can come again...)


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## kcowan (Jul 1, 2010)

Freedom25 said:


> but real estate is overinflated and has been for years, so lets get it over with so that normal safer times can come again...)


I agree but the politicians seem intent on keeping the bubble inflated as long as they can...


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## Mall Guy (Sep 14, 2011)

Berubeland, I just can't get there with you (although I do respect your various opinions). I'm not saying that all REITs are a buy at this moment (CDN banks are having a nice pull back, and some of the big REITs have about the same yield). Again, stick with the quality mainstay names. Not saying I don't like the Centurion REIT story, it just that it is apples to oranges to the "real/stable/investment grade" REIT names. If the likes of Sobeys, Metro, Canadian Tire, Winners, Loblaws, Wal-Mart, Safeway, Canada Trust, CIBC, Tim Hortons, Target (all picked from the list of top tenants of the larger REIT names) can't pay their rent, then we are all in for a world of pain in which consumer staples, financials, industrials etc., go south.

REITs offer geographic, market segment/asset class and tenant diversification. Larger market cap REITs have a large percentage of institutional investors and pension fund partners. Many wealthy individuals/families use R.E. as a staple against inflation (including the Queen!). 

I will agree that the capital markets did "shut down" for a period in 2008 - during the global financial crises in which banks wouldn't lend to other banks - but both the equity and debt markets are currently wide open. As well, look at the leverage of the more established REITs - 50 to maybe 60 %, not 75 to 90% in the last R.E. crash! (ie O&Y). And always look at the pay-out ratio (CREIT !). Lenders tightened their belts coming out of 2008, and the REITs are living by the new rules. The big difference is that there aren't CMBS high ratio mortgages available any more - the stuff the financial crises was made of !

Sherway Towers was trying to get construction financing (the riskiest time in development). Take-out financing for complete projects, and refinancing for well run REITs was generally available (bigger bond spread, but available) accept at the worst of the global melt down (when RBC, BNS, BMO shares dropped in half - bought me some of those as well as HR.UN @ $6 and REI.UN @$12).

Most of the big REITs have whether the various storms - yes, there has been fall out from Blockbuster, Tabi, Quiznos, Circuit City, Please Mum, Hart, SAAN, HMV, CD Plus, Movie Gallery . . . and more recently, what will happen to the Zellers stores not purchased by Target ? All and all, business as usual, after all, when was the last time you shopped at Eaton's, Towers, Woolco, or ate at Mother's Pizza, O'Toole's Roadhouse or The Ponderosa ? As long as the real estate is good (sorry - location blah, blah, blah) the industry will morph to the next best thing!

Like all investments, choose well !


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## kcowan (Jul 1, 2010)

I think Mall Guy has demonstrated that he knows what to look for in buying a REIT. Without this insight into the health of the prospective tenants, REITs are risky.


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## Freedom25 (Dec 3, 2011)

Mall Guy (and anyone else), what do you think of the index fund REITS like XRE? I've read (and agree with) others who say it's not worth the MER for such a small handful of stocks, but on the other hand it's hands-off to buy it that way. Are those quality REITs in the XRE basket?


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## Mall Guy (Sep 14, 2011)

XRE has, for the most part, quality (institution type) names in their holding. However as it has been pointed out in a couple of different threads (and in a nice article by Canadian Capitalist) not sure you couldn't get a slightly better yield on your own. Six of their top 10 holdings have a higher yield (some as much as 1-2%). But whether to buy depends on many factors - same as everything else - size of investment, time horizon, risk tolerance - all of these would factor into the decision to buy XRE (4.7%) or the higher yield in Riocan (5.28%), or the lower very stable Boardwalk (3.49%). I think I would buy XRE over ZRE which hold a broader basket on an equal weighting. There are also some other very nice buying opportunities for those willing to take on a bit (or a lot) of risk . . . Different styles and preferences is what make a market!



http://www.canadiancapitalist.com/unbundling-the-ishares-cdn-reit-index-fund-xre/


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## Jon_Snow (May 20, 2009)

I have done very well with XRE this year... I think I bought in during the August lows. Its one of my best performing assets since then. No complaints whatsoever.


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## larry81 (Nov 22, 2010)

Jon_Snow said:


> I have done very well with XRE this year... I think I bought in during the August lows. Its one of my best performing assets since then. No complaints whatsoever.


i like my XRE too, slowly dripping new units each month


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## londoncalling (Sep 17, 2011)

I don`t think anybody has anything against XRE as an investment but it is just as easy to create your own XRE by buying some of the same holdings. I would agree that it would be cheaper and smarter to just purchase the holdings of the indexes for a couple reasons

1) No MERs if these are long term holds one should buy the stock and eat the commissions instead of handing over a percentage repeatedly while you hold. Note this MER is taken off the top and has no relation to the funds performance. I know they are lower than mutuals but any MER is still money being taken from me.

2) You are not subject to the games these funds play regarding holding requirements (percentages,market caps etc) Sometimes these funds don`t even follow their own guidelines. Take the Div aristocrats for example. I had planned to `copycat`some of the larger holdings till I learned they had reinstated some holdings that fell far short of their 5 consecutive years of div increases. Not that I am against holding the said stocks such as the big 5 banks Just seems pointless to make a guideline and ignore it. Makes me wonder what else they are doing.` 

I guess it comes down to why buy something that looks like a herd of cows (look like cows, sound like cows, act like cows but aren`t actually cows) when you can actually choose each cow and put them in your barn and decide when you want to sell them, butcher them, breed them etc.

I guess the simple answer is preference of managing your funds vs couch potato. The other argument is that individual selection never consistently beats the index however if I am copying the index it should be close or possibly better.

I myself, see nothing wrong with index funds for passive investors. I however, would prefer to hold the stocks that comprise the fund. It forces me to watch my holdings and keep up on what my investments are. As mentioned by several others on this forum there are many ways to make or lose money and people should do what works for them. 

Cheers


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## Dmoney (Apr 28, 2011)

londoncalling said:


> I guess it comes down to why buy something that looks like a herd of cows (look like cows, sound like cows, act like cows but aren`t actually cows) when you can actually choose each cow and put them in your barn and decide when you want to sell them, butcher them, breed them etc.


Awesome analogy. 

The REIT index is extremely simple to recreate yourself. XRE you've got 13 holdings, 25% is RioCan. ZRE has 20 holdings each at ~5%.

I'd say it's better to do yourself and drop the ones that don't match your profile. You might end up with 5-8 REITs, and you can weight them however you would like. 

With an MER of 0.55%, if you hold 5 equities, you are ahead if you invest just under 10K, if you hold 13 you are ahed if you invest just under 25K (assuming $10/trade). That's just your first year. If you don't rebalance you're scott free from that point forward.


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