Risk in REITs

[tooqk4u22]

A little article about REITS. I think there is significant risk in REITs, especially apartment REITs, and Bonds due to the currrent rate environment. Do I think there is a bubble - not in REITS overall, but maybe apartment REITs and bonds. Personally I wouldn't and don't have a significant portion in these investments right now.

http://articles.marketwatch.com/2012-10-29/investing/34785141_1_reits-ffo-kimco

[elindbe2]

Are we talking risky compared to equities and bonds?  Inflation, rising interest rates and a reduction in the flow of cheap credit would have a significant impact on both of these as well.  But I agree a levered mREIT is going to be riskier than a bond fund, hence the much greater dividend.

[tooqk4u22]

Are we talking risky compared to equities and bonds?  Inflation, rising interest rates and a reduction in the flow of cheap credit would have a significant impact on both of these as well.  But I agree a levered mREIT is going to be riskier than a bond fund, hence the much greater dividend.

Agreed that it will have an impact on all of them except that it will have a greater impact REITS and bonds:

 - bonds becaue they inversely related and with rates as low as they are even a small increase can result in a big capital loss (obviously doesn't apply if held to maturity which only is possible if you own actual bonds and not bond funds). Do the math - 10-year US Treasury is currently 1.7% if it goes to 2.0% (hardly high and hardly a big move) the underlying bond loses 15% of its value.

- REITs, because they use good amounts of leverage and cap rates (how commercial real estate is valued) is highly correlated to bonds.  Apartments (the favored child right now) are topped out due to high leverage, low rates, and rental increase assumptions that are crazy.  Industrial (the less favored child) REITs are probably the most stable (dependent on economy but not jobs as much, low capital costs) but yields are low right now here too, Office (the stepchild) REITS may be the best buy but they are so out of favor due to crappy economy, no jobs (need jobs for employees to fill those offices), and changing space usage (telecommuting, open/communal work environments). 

As for mortgage REITs there is more risk there as you elude - these have the worst of both. 

**Edit - Add that the other reason is that operating companies (Home Depot, MMM, etc.) generally have a more flexible balance sheets and income statements, which is why during the downturn you saw and continue to see strong profits even as revenue growth slowed.  When growth slows working capital gets converted to cash that is used to reduce debt and they can reduce expenses (layoffs) and delay capital investments to manage through tough times.  REITs don't have this luxury - high debt, low cash flow, largest expenses are property related (taxes, insurance, repairs, etc.) that can't really be cut. 

[KingCoin]

Do the math - 10-year US Treasury is currently 1.7% if it goes to 2.0% (hardly high and hardly a big move) the underlying bond loses 15% of its value.

I'd check that math. Even if the duration on those bonds is 10, the loss will only be 3%.

Though, the point about REITs being risky is well taken. The Vanguard REIT index fell over 75% peak to trough during the crisis, so it's important to not view REIT ownership as a convenient equivalent to property ownership.

[arebelspy]

KingCoin: Selling on the secondary is generally what people refer to in loss of bond value, not in potential loss of holding to maturity at the old rate versus new one.

[elindbe2]

So the question becomes where to go for yield?  S&P seems to have been trading in a range since the late 90s/ early 2000s.  Bonds yield little and have significant interest rate risk and inflation risk.  Bank accounts have negative real yield.  Owning rentals might be a good option, but it's a lot of work.  Dividend stocks might work.  What are your thoughts?

[KingCoin]

KingCoin: Selling on the secondary is generally what people refer to in loss of bond value, not in potential loss of holding to maturity at the old rate versus new one.

Right. If the yield on a bond with a duration of 10 rises 0.30%, the value in the secondary will fall ~3%, not 15%.

[grantmeaname]

So the question becomes where to go for yield?  S&P seems to have been trading in a range since the late 90s/ early 2000s.  Bonds yield little and have significant interest rate risk and inflation risk.  Bank accounts have negative real yield.  Owning rentals might be a good option, but it's a lot of work.  Dividend stocks might work.  What are your thoughts?

I'm holding a broad stock market fund. I haven't seen any evidence that a dividend strategy outperforms a total return strategy, and they're treated less favorably for tax anyway.

The only reason that the S&P is trading approximtely level compared to a decade or so ago (see chart) is that the P/E ratio is much closer to historical averages than it was in 2000. It's not that companies aren't producing much more value than they were in 2000 -- they are -- it's that that increase in value has come along with a decrease in investing enthusiasm, so the increase in earnings hasn't been associated with a corresponding increase in price. Considering that the P/E ratio is now at a historical average, it's not likely that this trend will continue from here in the long-run.

[arebelspy]

KingCoin: Selling on the secondary is generally what people refer to in loss of bond value, not in potential loss of holding to maturity at the old rate versus new one.

Right. If the yield on a bond with a duration of 10 rises 0.30%, the value in the secondary will fall ~3%, not 15%.

Gotcha. I misread your post and thought you were talking about something else.  ~2.7% loss in bond value going from interest rates of 1.7% to 2%.   ~6.7% loss though if it's a 30-year (though original comment was on 10-year treasury).

[elindbe2]

It's not that companies aren't producing much more value than they were in 2000

Can I ask what measure of value are you using?

[tooqk4u22]

KingCoin: Selling on the secondary is generally what people refer to in loss of bond value, not in potential loss of holding to maturity at the old rate versus new one.

Right. If the yield on a bond with a duration of 10 rises 0.30%, the value in the secondary will fall ~3%, not 15%.

Gotcha. I misread your post and thought you were talking about something else.  ~2.7% loss in bond value going from interest rates of 1.7% to 2%.   ~6.7% loss though if it's a 30-year (though original comment was on 10-year treasury).

Your right -sorry for the bad math - I forgot about the par value when the bond matures.

[tooqk4u22]

It's not that companies aren't producing much more value than they were in 2000

Can I ask what measure of value are you using?

See link for chart of S&P Earnings adjusted for inlation. 

http://www.multpl.com/s-p-500-earnings/