I spent some time today talking with Brad Case about the REIT and real estate markets going into the New Year. Brad is a Senior Vice President, Research & Industry Information at the National Association of Real Estate Investors and has become a valuable source of information when it comes to real estate investing. Brad is one of the few upbeat voices on REITs as we enter 2017 and we spent some time talking about his expectations.
First of all, he pointed out that REIT fundamentals are very strong. Occupancy rates and rents are rising right now. New construction is still well below historic lows, and the absorption rate for new properties is very high right now. There are signs that the economy is picking up and higher GDP growth is closely correlated with high returns for commercial real estate and the REUTs that invest in those assets.
Brad also shared with me the results of his recent research in yield spreads and REIT returns that is very bullish for long-term returns for real estate investment trusts. He found that there the relationship between the spread between REITs and the 10-year Treasury yields is highly predictive of how REITs perform over the next five years. The higher the spread better REITs performed. He told me that right now the spread is pretty high and is predicting a five-year average annual total return of over 14%.
To make sure he did not see accidental conclusions he tested the yield spread using other fixed income assets and found that it held true when using different maturities of Treasuries, corporates, and even high yield. All of them worked, and all of them are bullish with the high yield spread being at one of the highest most bullish levels ever.
He shared his data with me, and the relationship is pretty solid. The spread relationship showed that it was a fantastic time to be a buyer of REITS in 203 and 2008 when some of the highest reading ever were recorded. The yield spread went negative in the first six months of 2006 and as we all know that was a terrible time to be a buyer of anything. Spreads were also at very low levels in 1999 preceding a period of very low REIT returns and returned to bullish levels after the internet crash was delivered five years of outstanding average annual returns.
In a recent article on the NAREIT website Brad summarized the relations between Treasury and REIT yields writing “When Equity REIT yield spreads were negative, as they were in 1997 and again around 2006, forward-looking Equity REIT total returns tended to be disappointing: positive on average, but by only 2.68%. When yield spreads were higher, though, forward-looking total returns tended to be higher as well: in fact, when yield spreads averaged 2.0% or more, returns over the next four years averaged an amazing 21.13% per year.”
I am not as unabashedly bullish as Brad Case, but neither am I rushing to sell the majority of my REITs and real estate securities. Most of the bankers I have talked with in recent months are quite happy with the CRE and multifamily markets in their service areas and don’t see any imminent signs of collapse. Occupancy rates are decent, and in the vast majority of US markets, there are no signs of the dramatic overbuilding and excessive risk-taking that usually proceeds a serious setback. If we get a decent stock market pullback anytime soon, I will become a serious buyer of some of the REITs on my shopping list.
This is one of my favorite times of the year. The holiday is part of it(more on that in a moment) but the new release list from publishers is reaching peak levels and it my Kindle reflected the weight of the stuff I have downloaded in the past few days I would need a wheelbarrow to haul it around. Right after Christmas every year we always get new books from WEB Griffin and Jack Higgins, and they both have a new one due this year as well.
As for the Christmas holiday that starts Saturday when we head out to so the shipping for food wine and liquor for the Christmas Eve Open House. MY wife turns several shades of several different colors when she sees how much I spend on this bash every year, but it is a long running Melvin tradition. We open the doors to friends and neighbors and every year we meet some new neighbors that pop in for a few minutes or a long evening. At some point there will be singing, mainly Christmas carols but I have vague memories of my sons belting out a few badly off-key choruses of Sweet Child of Mine around midnight or so. It is a fantastic time and one of my favorite holiday traditions.
That’s about all of this week. Have a great week.
At last, it is time for