Real Estate Inv. Trusts: REITs
A Friendly Debate about the Bottom

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By Reitnut
February 4, 2008

Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light. How are these posts selected? Click here to find out and nominate a post yourself!

Warning: Long post ahead. Not only'll tell you virtually nothing about whether you should (or should not) jump on REIT stocks at the present time. Another caveat...If this post is a bit more incomprehensible than usual, it's because I am tired after watching that incredible Super Bowl game. It was the only football game I watched this year, but, wow, was it worth it!

We Fools know, of course, that it's impossible to consistently "call" market tops and bottoms, and make investment decisions accordingly. And yet, human psychology is such that investors won't buy when they should - when blood is running in the streets. Nobody wants to try to "catch a falling knife." Despite WEB's admonition that "when others are greedy we should be fearful and that when others are fearful we should be greedy," we all want to wait for "the bottom" before jumping in.

Ha! Would that it is so easy! Have REIT stocks reached "a bottom?" Is now the time to load up? REITs have been performing pretty well this year; the RMZ is up a little over 3% since December 31, handily beating all major equity indices. Is this the green light that market-timers have been waiting for? Has the knife finally hit the ground, safe to pick up?

I would like to use this forum to try to show why that call is impossible to make with confidence, and why picking market bottoms, like forecasting the next Britney Spears antic, is an effort in futility. I'll try to show this by a make-believe dialogue.

Bully Taurus: REIT stocks have hit bottom; time to buy! Look at how they're acting! For the first time since early '07, they are kicking the crap out of their fellow equities. This trend has lasted for several weeks. The stocks decline at market openings, but finish strong! Momentum is now on our side!

Ursa Beare: Gimme a break. This "outperformance," up 3% year to date, is not exactly impressive; indeed, it is merely the sound of a dead cat bouncing. We'd need to see much more impressive performance before we can be sure that REIT stocks are on the mend.

Bully: But it's not just REIT stocks that are acting better. We have the support of the entire retail and financial sectors; just as REIT stocks were trashed last year, so were they. But this year they are coming back, as the S&P Retail index (RLX) is up 3.5% (perhaps not so coincidentally, about equal to REITs' gains this year) and the Financial Select ETF (XLF) is up 2.6% - yet the S&P is down 5% year to date. This shows that investors are now discounting an improving consumer-driven economy later this year, as well as the end of the credit crunch.. These prospective developments, of course, are very favorable for REIT organizations.

Ursa: I am not impressed. January is always a month in which the sectors that have been trashed in the prior year snap back, following tax-loss selling and portfolio window-dressing. It's much too early to make anything of relative performance trends. Look at reality, Bully. We got another dose of it on Friday, when the US Labor Department reported an actual shrinkage of jobs in January. That's hardly conducive to a turnaround in REIT stocks - which are, to a large extent, sensitive to the US economy.

Bully: But look how the markets reacted to that disappointing job report. They moved up, and REIT stocks, in particular, were up BIG. On Friday, the RMZ levitated 3.8%, thumbing their noses at the weak jobs report. When markets shrug off bad news, that's a sign that we've hit bottom. Also, according to this week's Barron's ("The Trader"), the stocks that are reacting well following earnings announcements (even those that mildly disappoint) are the financials and the consumer discretionaries, while the techs and the consumer staples are acting poorly (even when the news is pretty good). This shows that the former group has hit bottom, while the latter will underperform. REITs are in the former category. Leadership is changing!

Ursa: That means zilch. While Simon acted well on Friday following its release of Q4 earnings and modest downward guidance for 2008, Duke's shares reacted poorly, earlier in the week, to its disappointing news.

Bully: But Boston Properties stock was a horse, rising 7.2% last week even though the dummies sold it off when they missed their numbers on Tuesday and guided lower for 2008.

Ursa: I am still unimpressed. The strong action of REIT stocks in some recent sessions was merely short-covering by some of the newest converts to the bear camp. These johnny-come-lately shorts, perhaps reacting to the b.s. about GGP's "pending bankruptcy," are running for cover, and trying to minimize their losses. You should know by know never to trust sudden and violent price spikes during bear markets; they are as fleeting as a politician's promise..

Bully: Let's get off the momentum topic. The Fed has been very accommodating, cutting the Fed Funds rate to 3%, and the markets predict further easing. This is going to have a tremendously beneficial impact upon the US economy in the second half, aided by the politicians, cowed by voters in an election year, who will soon pass a stimulus package. The markets are beginning to anticipate this. Time to climb aboard the REIT train, as it's about to leave the station!

Ursa: Ha, ha! These lower rates won't help anyone other than the goofy banks who bought all that toxic waste. Lending standards are tighter than a Swiss banking gnome, and so most borrowers, who have little equity in their homes, won't be able to take advantage. The Fed is pushing on a string. Consumers are still not spending, and we haven't yet seen the worst. Foreclosures will be rising as those idiotic ARMs and "piggyback" mortgage loans are reset at higher rates, while jobless claims are rising. The next shoe to drop is credit card loans. None of this is good for REIT stocks; whether or not they outperform other equities is irrelevant - it's too soon to buy.

Bully: Listen, dummy. All that is necessary for REIT stocks to bottom is that conditions are stabilizing; we don't need a strong uptick in consumer spending or employment growth for these shares to be attractive to investors. All that's needed is that we can feel comfortable in assuming that the "R-word" will be spoken of in past sense next year, and that the weakness in the US economy won't be horrendous. And, despite, the fears of so many, there are zero signs that the global economy is beginning to unravel. Commodities, including oil prices, haven't cracked. Assuming the global economy remains reasonably healthy, any recession here will be shallow and short.

Furthermore, REIT preferred stocks are performing very well. What that suggests to me is that investors are becoming comfortable with a scenario well short of Economic Armageddon. It also shows that spreads are narrowing, which is a precursor to investors' greater comfort level with risk - and thus higher stock prices (including REITs).

Ursa: Those preferred stock prices mean nothing, Bully. They were tremendously oversold at the end of last year, and are merely bouncing dead cats. Look at the CMBS market, which remains moribund. Nobody's lending on commercial real estate and, until they do, the specter - and reality - of rising cap rates and continued illiquidity will haunt REIT shares. At the very best, REIT shares will stabilize. But they won't rise from present levels, so it's too early to buy them.

Bully: By the time there is clarity on cap rates and the lending environment, REIT stocks will be 15% higher, and everyone will be just starting to figure things out. It is only then that we'll see newspaper articles suggesting that the Big Decline in commercial real estate prices was grossly exaggerated. Sure, there has been, and will be, weakness in some real estate assets, mainly in lesser quality properties in mediocre markets. But that doomsday scenario was half-baked (and overdone), a fiction of the hedgies who were making money hand over fist shorting REIT stocks and then whispering lot of b.s. into the ears of their friends in the news and financial media.

Ursa: You speak of b.s. You should know, Bully. Do your friends a favor and tell them it's not yet time to buy REIT shares; indeed, they should short all REIT rallies.

Bully: You just don't get it, Ursa, do you. You couldn't find your own bottom with both claws, let alone a market bottom.

OK, enough of that. As you might tell from the foregoing discussion, both bears and bulls have their points, and I have no idea where REIT stocks trade next month, or even in July. But, to repeat myself once again, those with a longer-term time horizon would be doing themselves justice to fill pre-existing REIT allocations now, and not worry whether they are 5-10% higher or lower in March.