The last seven years have been fantastic for real estate and REIT investors. The Vanguard REIT Index ETF (VNQ) has almost quadrupled over that time and the Dow Jones REIT ETF (RWR) has actually more than quadrupled.
The buying from large investors looking to allocate funds to a recovering real estate market, as well as yield-seeking individual investors, has provided substantial buying pressure in the sector and early investors have been well rewarded. Both the VNQ and the RWR have paid generous dividend yields over that period of time.
Speaking at the Goodwin Proctor Real Estate Capital markets conference in Manhattan last week, Jim Sullivan of Green Street Advisors described it as nirvana, but warned that he was starting to see some cracks in the marketplace.
What’s more, Sam Zell recently told Bloomberg that “With the pricing currently available in the commercial real estate market, it is very hard not to be a seller.”
That said, It may be time for investors to part ways with some highly appreciated real estate investment trusts that now trade at premium valuations.
REITs to Ditch: Public Storage (PSA)
Dividend Yield: 3%
Public Storage (PSA) owns and operates self-storage facilities around the country and the performance of the REIT has been spectacular. Public Storage’s stock has risen fivefold from the market bottom in 2009 when real estate was the world’s most despised asset class, and shareholders have collected generous dividend streams.
Buyers back in 2009 were buying the company at a little over 1.5 times book value with an EV/EBIT of 10, which is a bargain for a company that has been around since 1971 and dominates the self-storage industry.
Today, the shares trade at 8.5 times book value and the EV/EBIT is 36. Public Storage still is a great company that dominate the industry, but the stock is just too expensive to own at the current price.
REITs to Ditch: AvalonBay Communities Inc (AVB)
Dividend Yield: 3.3%
Avalon Bay Communities (AVB) is one of the largest apartment owners in the United States, boasting 83,696 apartment homes in 11 states and the District of Columbia. Investors who predicted the move to apartment living by frustrated former home owners, retirees and post-credit crisis millennials have done very well with this REIT.
In 2009, you could have bought the shares at a small premium to stated book value and an EV/EBIT ratio of around 10. Since then the stock has risen about sixfold, and valuations today are much more generous with a price to book value of 2.35 and an EV/EBIT ratio of 34.
There is a time to buy and a time to sell, and for large-cap multifamily REITs we are much closer to the latter. Even after the recent dividend hike and 2% haircut Monday, AVB shares barely yield more than 3%, so it is not worth holding as income play at this level either.
REITs to Ditch: Equity Residential (EQR)
Dividend Yield: 3.1%
I would sell my shares of Equity Residential (EQR) right now simply because Sam Zell has been selling off the REITs holdings, especially in suburban markets. He is building his cash position in advance of what he sees as a pullback in the apartment market.
While this is exactly the right thing to do if we start to see a selloff in multifamily REITs, Equity Residential will fall along with the rest of the sector. In 2009 you could have invested alongside Zell at a small discount to book value with a single digit EV/EBIT ratio when the markets were in freefall and shares would have quadrupled while dividends to date would equal more than half your cost of the stock.
Today, the shares trade at 2.64 book value and nearly 40 times its EV/EBIT ratio.
Sam Zell is one of the best real estate investors of all time, and he is selling apartments. So should we.
As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities. He is the author of the Banking on Profits newsletter covering the community bank stock opportunity and the Deep Value Report that seeks out undervalued stocks that are likely to survive until they thrive and capture the value effect that has been proven to beat the market over time.