Playing the Real Estate Game

This column was originally published on RealMoney on Feb. 8 at 8:53 a.m. EST. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

The bidding war for Equity Office Properties (EOP Quote) finally came to a conclusion yesterday, but will this also bring to a close the incredible price run for commercial real estate properties and REITs? Some believe this record-setting $39 billion buyout will mark the top for this sector, which, as measured by the iShares Dow Jones Real Estate Trust (IYR Quote), has gained some 90% over the past two years.

REITs have obviously performed well, but one of the biggest price drivers has been takeover activity, which has pushed valuations to frothy levels. With the Equity Office deal complete and the bidding for Mills (MLS Quote) nearing a conclusion, one has to wonder if, now that returns on investments are less attractive, the takeover activity and the accompanying rise in prices will cease.

The End Is Near, Not Here

However, many analysts argue that while the boom may indeed end eventually, the time is not now. In fact, some make the case that the cash buyout for Equity Office, which takes it private, will spark the shares of many other publicly traded REITs.

They point out that nearly half of Equity Office's shares were owned by funds with a dedicated allocation to the sector, meaning that about $18 billion needs to find a new home quickly. In addition, Equity Office was the second-largest component of the IYR, representing 4.8% of the exchange-traded fund.

Some evidence of this reallocation could be seen yesterday as shares of Vornado (VNO Quote), the loser in the bidding war, jumped almost 7%.

There certainly seems to be plenty of money still looking to be invested in commercial real estate companies, but I believe the gains in price will slow. In fact, I see a good chance for a pullback at some point in the next few months.

Options Play Can Deliver Returns

Without trying to time the market too finely, here's one way to play the scenario of further near-term price gains followed by a correction. You could use options to employ a form of a calendar spread in the IYR.