Right here in Money and Markets — in May 2007 — I issued one of my most important and prescient warnings ever.
I proclaimed the multi-year run in the real estate investment trusts, or REITs, over. And I told you … in no uncertain terms … to dump every last REIT you owned, warning:
“We’ve had way too much excess money and credit floating around out there. It’s causing what I call a series of ‘rolling bubbles.’ Residential real estate had its turn in 2001-2005 … and since about 2003, commercial real estate has been experiencing its own private mania. But a turn may finally be at hand.”
What happened in the wake of that piece? The iShares Dow Jones U.S. Real Estate Index Fund ETF (IYR), a benchmark for the sector, began a sickening almost-two-year slide from $86 to just $21. Investors who failed to heed my warning lost a stunning 76 percent of their money through March 2009.
The Federal Reserve’s largesse and other factors helped turn REITs around at the time, with many doubling or even tripling off their lows. But even with that rally, the IYR is STILL trading more than $26 below where it was when I issued my landmark warning. More importantly, I believe …
“Phase II” of the meltdown is getting underway!
What Prompted the
Recent REIT Rally …
REITs own and manage commercial property. Think warehouses where massive amounts of goods are stored … retail shopping centers … and those suburban office buildings you commute by every day. They take in money from rents, and pay out handsome dividends to shareholders.
The anemic economic rebound we’ve seen in the past couple years helped pump a little life into the commercial real estate sector. A report from research firm Cassidy Turley noted that demand for retail space has generally climbed since July 2010. Meanwhile, CoStar Group said a net 80 million square feet of commercial real estate space was absorbed in the past year. That helped stabilize vacancies in the industrial and warehouse subsectors.
At the same time, the Fed pumped up virtually every asset class in the world by flooding the markets with easy QE2 money. That forced large investors like pension funds and life insurers OUT of low-risk Treasuries and IN to higher-yielding investments, such as junk bonds and REITs.
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| Commercial real estate investors buy for the cash flow. |
Investors also piled into physical real estate in major financial and political centers like New York and Washington. Why? Because a commercial property’s value doesn’t stem from the steel, concrete, and glass it’s built of. It’s the income stream from rents that investors crave — making commercial property almost like a type of higher-yielding bond.
… And What’s Telling
Me It’s Now Over!
But here’s the critical point: That’s all “rear view mirror” stuff! The end of QE2 is looming, and political pressure will keep the Fed from launching another money printing program. The search for yield is starting to blow up in investors’ faces, with junk bonds and riskier mortgage securities starting to fall sharply in price.
At the same time, the residential real estate sector is already rolling over again — bad news for commercial, which ALWAYS lags residential. And the broader economy is weakening again, as I’ve detailed over and over in recent columns. All of that tells me the two-year long rally in REITs is kaput. Over. Done.
You can already see commercial property owners tentatively heading for the exits. To cite just one city as an example, look at Chicago …
The owner of the Chicago Board of Trade, CME Group, just announced it would try to sell its landmark 80-year-old Art Deco towers. The Willis Tower (the former tallest building in the U.S. previously called the Sears Tower) was also just put on the market a couple weeks ago. That adds even more properties to the 15-strong-and-counting pile of downtown buildings up for sale.
Meanwhile, the same Markit CMBX indices that foretold the first phase of the crisis are rolling over again. Those indices track the value of commercial mortgage backed securities (CMBS), and their recent declines suggest that smart-money investors are once again starting to flee.
Finally, there’s this chart of the IYR. You can see that it’s been stair-stepping higher for the better part of the past two years. But a few days ago, it knifed through that uptrend line on the heaviest trading volume in several months.
What to Do …
before It’s Too Late!
If I’m right, this is just the beginning of what will be a nasty spill in the REIT sector — the second since 2007. So if you own these stocks, whether for income generation or capital gains, my advice to you is simple. Sell and don’t look back.
What if you have real estate stocks you can’t sell, for whatever reason? Or commercial property you can’t unload? Then I would strongly recommend you hedge that exposure.
One option to consider is inverse real estate ETFs. The ProShares Short Real Estate (REK) is designed to rise 1 percent for every 1 percent decline in the Dow Jones U.S. Real Estate Index, for instance.
You can also buy leveraged inverse ETFs that rise even faster in value when REITs fall. But as with many leveraged ETFs, long-term tracking error is a concern, especially if volatility picks up.
So if you want a more active strategy — one that allows you to get in to these ETFs, grab profits, then get back out — consider my Safe Money’s Crisis Trader . I believe it’s tailor made for this environment.
Bottom line folks: With the economy weakening, residential real estate clearly rolling over, and savvy investors looking to dump their commercial real estate exposure, it’s time to get your portfolio out of harm’s way.
There’s no telling how nasty Phase II of this crisis will get. But considering how much of a disaster Phase I was, I don’t think you want to stick around and find out!
Until next time,
Mike
P.S. With Safe Money’s Crisis Trader your satisfaction is fully assured under our 100% money-back membership guarantee. So you’ve got nothing to lose!
Mike Larson graduated from Boston University with a B.S. degree in Journalism and a B.A. degree in English in 1998, and went to work for Bankrate.com. There, he learned the mortgage and interest rates markets inside and out. Mike then joined Weiss Research in 2001. He is the editor of Safe Money Report. He is often quoted by the Washington Post, Reuters, Dow Jones Newswires, Orlando Sentinel, Palm Beach Post and Sun-Sentinel, and he has appeared on CNN, Bloomberg Television and CNBC.
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REK is up since the buy recommendation. But let’s not lose those gains like the last time we owned this from 11/2010 until the sell and take 8% loss recommendation in February.
Question: Do you anticipate all REITs to be downgraded in the months ahead by Weiss Ratings? It would be interesting to see the Weiss ratings trend for REITs as a category.
I notice that everytime there’s a stock market correction the chicken littles at Weiss Research claim the sky is falling. There was a deeper dip that fell just below its 200 day ma between Apr and Oct 2010 and IYR recovered. It looks like it might be headed to it’s 200 day ma but if the economy is just going through a soft patch like it did a year ago IYR will in all likelihood recover.
Mike
Firstly thank you.
My real world experience in the REIT sector was to see Macquarie Bank ‘s retail platform in Australia collapse from about $2 a unit all the way down to 10cents. The managing director was in the Australian financial review at the time appealing for support against an income stream showing a then forty percent return at 10cents a unit. Support had then dropped completely. I risked $100,000 and bought 1,000,000 investment units which I have since sold for 57cents. I have been reviewing your advice for some time, picking out the information that fits my investment profile and it works for me. Thank you once again
Mike did recommend selling REITs, which could have included IYR, in May 2007. But did he subsequently recommend buying IYR when in rose above its 200 day moving average in Fall 2009? I thought not!
quickbrownfox: your comment is unfounded. I clearly recall Mike recommending REIT purchases a while back. In fact I was confused by his turnaround but now I see what he meant.
Mike,
I remember that you specifically called a bottom in one of your newsletters for residential real estate several years ago. I don’t think it’s gone up much since then. Possibly declined. Now you say it’s rolling over in Phase II?
I’d appreciate your comments.
Thanks.
Annaly ( NLY ) Capital Management !!! I’m in for the juicy dividends . A keeper among many dividend payouts in my portfolio !!