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Why REITs Are Dangerous Right Now

By Tom Dyson, publisher, The Palm Beach Letter
Monday, July 26, 2010

"The housing market... is stalling again," says the Wall Street Journal this week.
 
On one hand, demand has evaporated. The government was giving out $8,000 tax credits for buying a new house. On April 30, the program ended. Naturally, anyone who wanted a house bought one before April 30. Now, there aren't any buyers.
 
Despite record-low mortgage rates, mortgage applications for home purchases have collapsed more than 40% since the April deadline. Meanwhile, 7 million homeowners are behind on their mortgage payments and 11 million more homeowners are living in houses worth less than the mortgage. So there are millions more foreclosures to come...
 
I don't know of any way to short housing prices... and I'm not sure you'd want to, anyway. The problems are already "baked in." But there are ways to profit as the real estate market falters once again...
 
 
The oversupply in the housing market is hurting homebuilders. With prices so low, homebuilders can't make profits building houses. This week, the U.S. Census Bureau reported homebuilders started construction on new houses at the lowest rate since October 2009.
 
This chart shows the evidence. It's a fund of homebuilder stocks. This fund has fallen 30% since May 3 and remains in a powerful downtrend...
 
 
The decline in activity is also hurting the building-supply market. Look at this chart of lumber, the raw material of new houses. Lumber prices have collapsed 39% since April 21.
 
 
After these huge collapses, I think it's too late to short homebuilders and building-material suppliers. Instead, I recommend you look at shorting real estate investment trusts (REITs)...
 
REITs are baskets of real estate investments trading on the stock market. REITs can buy almost anything, as long as it's related to real estate. Normally, they invest in common property like office buildings, hospitals, and shopping malls. Some REITs specialize in more obscure things like timberland, warehouses, or even mortgage debt.
 
Right now, vacancy levels in commercial real estate are rising, expenses like taxes and insurance and utilities are up, and rent receipts are falling. These are the three most important fundamentals in commercial real estate... and they should be causing commercial real estate prices to fall like the other areas of the real estate business.
 
Because REITs have cut dividends, yet their stock prices have risen, the average yield for equity REITs during second quarter of 2010 was 4.1%. Ten years ago, REITs were yielding 10% on average. At these low yields, there's no value in REITs. I think investors looking for safe investment income should steer clear of the lot of them. You might as well buy a 10-year Treasury bond yielding 3%.
 
The big commercial real estate fund, IYR, is only down 11% from its peak three months ago... but it should be down a lot more. With home prices, homebuilders, and lumber getting big haircuts recently, I bet REIT prices are next in line.
 
Good investing,
 
Tom




Further Reading:

S&A Classic: As Tom's essay makes clear, the real estate crisis that began five years ago is far from over. If you want to protect your wealth as the bust grinds on, you MUST understand how we got here. In August 2007, Porter Stansberry published a detailed explanation of what exactly went wrong. It's likely the best description of the housing bust you'll ever read. Find it here: What Caused the Housing Bust.
 
Early last month, DailyWealth readers got a heads-up on the coming fall in homebuilder stocks. Inventory was high, mortgage applications had just hit a 13-year low... and homebuilders were more confident than they'd been in two years. If you followed Tom's advice to drop your homebuilder stocks, congratulations. You sidestepped a quick 15% decline. If you're still hanging on, go back and read his arguments here: Homebuilding Stocks Are in for a Nasty Surprise.

Market Notes


NEW HIGHS OF NOTE LAST WEEK
 
Anheuser-Busch InBev (BUD)... World Dominator
Compania Cervecerias Unidas (CCU)... beer
Stonemor Partners (STON)... cemetery operator
Altria Group (MO)... dividend machine
Reynolds American (RAI)... cigarettes
Williams Partners (WPZ)... pipelines
Sunoco Logistics Partners (SXL)... pipelines
DCP Midstream Partners (DPM)... pipelines
Enbridge Energy Partners (EEP)... pipelines
Energy Transfer Partners (ETP)... pipelines
MarkWest Energy Partners (MWE)... pipelines
Boardwalk Pipeline Partners (BWP)... pipelines
Kinder Morgan Energy Partners (KMP)... pipelines
Core Laboratories (CLB)... specialty oil services
Deere & Co. (DE)... farm and construction equipment
Indonesia Fund (IF)... Asia up, the West not so much
Malaysia Fund (MAY)... Asia up, the West not so much

NEW LOWS OF NOTE LAST WEEK

Johnson & Johnson (JNJ)... health care giant
Western Digital (WDC)... hard drives
TradeStation (TRAD)... broker dealer

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