For those of an older age group, the term FOMO might sound like some new-fangled technology term. But it simply means "fear of missing out," which is an age-old problem in life and on Wall Street. It's particularly hard to fight FOMO when everyone seems to be in a buying mood -- which is the warning real estate investment trust (REIT) Four Corners Property Trust (FCPT 2.48%) has just given to investors, as it works to stay focused on buying at the right price instead of any price.
Examples of a FOMO market
For investors, there are any number of valuation metrics that can be examined to see if a stock is overpriced or on sale. The quick go-to for most is the price-to-earnings ratio (P/E), which basically says how much you are paying for a company per dollar it earns. The market's current P/E ratio is around 29 times versus an average of around 16. Another rough estimate of valuation is dividend yield, noting that the S&P 500 Index's 1.3% yield is near historic lows today. Investors should probably tread with caution.
Image source: Getty Images.
But that flows through to the corporate level as well. For example, in the real estate investment trust space, the key metric of valuation is the cap rate. Basically, the more you pay for a property, the lower your return, and thus the cap rate, is likely to be. The less you pay, the higher the expected return. Clearly, paying less is better. But in some real estate sectors today, that can be hard to achieve because investors are diving in with abandon, fearing they will miss out on a property.
For example, during strip mall landlord Kimco's (KIM 2.00%) third-quarter earnings conference call, President Ross Cooper noted:
We continue to see additional capital sources, new and old, gaining conviction in quality open-air retail, leading to the compression of cap rates. We are fortunate to be in a position with multiple investment strategies that enable us to be active when opportunities arise, but also patient when things become too frothy.
In other words, prices are high today and Kimco is treading cautiously.
Treading a fine line
Kimco just inked a big acquisition, buying peer Weingarten, leaving it with a huge 545 properties and ample redevelopment opportunities where it can put cash to work without having to buy new assets. Other sectors of the real estate space don't have the same dynamics and should be watched more closely.
For example, Four Corners Property Trust largely owns restaurant properties. It was spun off from Darden Restaurants a few years ago and is trying to diversify away from its former parent, which still makes up around 60% of its rent roll. Continuing to buy properties is a key lever to achieve this goal.
Notably, on Four Corners' third-quarter earnings conference call, an analyst pointed out that a recent multi-property deal the REIT consummated was at the lower side cap-rate wise. That prompted CEO William Lenehan to note: "I would say that, what we're seeing in the market, especially for larger well-marketed portfolios, is a portfolio premium, if anything." That's unusual, given that portfolio deals have historically been priced at a discount.
At another point in the call, however, the CEO noted: "If anything I would anticipate [cap rate] compression, continued compression. But as of today, we've been pretty consistent in the low to mid-six's as what we've been looking at to acquire."
Director Patrick Wernig added to this idea, saying:
We noted on our last earnings call that the pricing environment was very competitive for restaurants and retail net lease in general. Despite that pricing headwind, we've still been able to build out the pipeline in the mid-six cap rate area with high-quality tenants and real estate. Our pipeline sector mix for restaurants, auto services and medical is similar to what we've seen so far this year.
In other words, Four Corners recognizes that property investors are paying up for assets today, but it is trying to be as selective as possible. The problem, of course, is that it doesn't have the luxury of redeveloping its portfolio assets like Kimco does. If it wants to achieve its diversification and growth goals, it needs to buy new assets. Investors should keep an eye on the cap rates it reports on new deals.
Not an isolated incident
Here's the big picture: Kimco and Four Corners are just two REITs out of hundreds, many of which are facing increasing competition today. As you look at your portfolio holdings, you should pay extra attention to the cap rates that your REITs are talking about. The more they decline, the riskier the investments being made are likely to be. That's a particular problem in both strip malls and restaurants today, but not every REIT has the ability to just sit on the sidelines and wait for better deals.
