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The headline from Fortune reads, “Sure, there's some pretty scary stuff going on. But things aren't as crazy as the last time the property market heated up”. At first response the reader might think that Fortune is out to lunch. After all, stories are running daily within major publications that the current US housing bubble is without precedent. However, it should be pointed out that the above quote is from an article published more than 3-years ago…
Suffice to say, pouring over the housing statistics isn’t necessary at this point to determine whether a bubble exists or not. Rather, what has become obvious to nearly everyone – including Mr. Greenspan – is that parts of the US housing market are bubbling over with speculation. Even those that disagreed a bubble existed 3-years ago would have to agree – based upon their own bubble theories – that a bubble exists today.
“First, you get a lot of cocktail chatter. Everyone's talking about how much money they're making on housing. Then you see multiple bids and offer prices jumping above asking prices. That's when you have a bubble."
Craig S. Davis, president of Home Loans and Insurance Services at Washington Mutual. Mr. Davis disagreed that a bubble existed in the above Fortune article but listed the signals that might appear when a bubble forms.
Another Bubble in Real Estate Investment Trusts?
On October 9, 2002 the yield on the 10-year Treasury was 3.58% and the yield for all REITs (NAREIT) was 8.10%. Flash forward to today: the yield on the 10-year is 4.09% and the yield on REITs is 5.04%. In the last 32 months investors have gone from pricing REITs at 4.57 to 0.95 bp higher than the 10-year.
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History does not adequately explain what the consequences of contracting REIT/10YY gap might be. Nevertheless, that investors have become less risk adverse over the last 2-years comments well on why the gap in question has narrowed. Quite frankly, investors that have grown increasingly hungry for yield and REITs – despite not being able to take advantage of Bush’s dividend tax cut – offer a steady supply of dividends to satisfy this demand.
Keep in mind that since REITs must pay out at least 90% of earnings in dividends to receive tax advantages, and that any decline in REIT earnings will immediately impact payouts.
In summary, housing bubble fears have been around for a long time, but only recently has a plethora of anecdotal evidence emerged that rising real estate prices are leading to reckless speculation. And while REITs do not necessarily mirror happenings in the residential real estate market, they do abide by similar economics. Accordingly, given that housing statistics are usually released on a monthly basis and REIT statistics are updated daily, early warning of real estate woe may come from NAREIT rather than the US government or Fannie/Freddie. Specifically, keep an eye on the gap trend, which, in my opinion, currently demonstrates the adoption of greater and greater risk by the REIT investor. Assuming REIT payouts remain flat and the 10-year yield does not change that much (many do not think it will), it will take a significant fall in REIT prices before the gap in questions starts painting REITs in a more attractive light. A fall in REIT prices may presage an end to the unreal speculation taking place today.
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