Active Trader Update

Return to Article

Stocks Can't Fall? Check Out REITs' Retreat

Doug Kass

We learn from history that we learn nothing from history.
-- George Bernard Shaw

Back in early February, the real estate investment trust sector was the cat's meow -- it could do no wrong. Despite my pooh-poohing the sector's seemingly ridiculous popularity (and valuations) on Street Insight and even in a Barron's editorial, the group marched ever higher. Premiums to net asset value were at all-time record highs, dividend yields were at all-time lows (seemingly disconnected from the level of interest rates), multiples to funds from operations hit historically high levels -- and the entire sector was seen as takeover fodder.

In late 2006, Sam Zell made history by selling his prized Equity Office Properties to The Blackstone Group. Investors saw this transaction as confirmation of value. By contrast, I viewed the sale by the "smartest man in the room" as a cautionary sign.

The proximate cause for the REIT leadership: rising liquidity (in the form of mutual fund inflows and mergers). And, oh yes, the momentum fed upon itself as the traditional non-REIT investors had new company in the group in the form of aggressive fund managers who grazed on the price action like piranhas waiting for their prey.

Back in early February, the real estate ETF -- iShares Dow Jones U.S. Real Estate (IYR Quote) -- traded at $93 per share; today it is at $80 per share and doesn't seem to have an uptick, despite the market's overall strength.

With the benefit of hindsight, Sam Zell did sell at the top, and the liquidity benefits of the cash sale of Equity Office Products on the REIT sector never developed. With savvy Sam Zell top-ticking the sector -- as smart guys usually do -- the rest of the lemmings got caught holding the REIT bag.

I will never forget a glib Wall Street conference call at the height of the REIT industry's popularity in January (the firm is not being disclosed to protect the innocent!) in which the senior REIT industry analyst said the IYR could easily tack on another $10 to the upside (from the $92-$93 level) based just on the recycling of capital from the cash-out of the Equity Office Properties capital. Oops!

The similarities between the former popularity and momentum in REIT shares -- which has seemingly evaporated overnight -- could (and should) provide a lesson to investors in the (broader) equity market today. The conditions are eerily similar: the ready (and glib) acceptance of a new investment paradigm, massive liquidity, a bubble in credit availability and terms, a plethora of merger deals and the feeding frenzy of share price momentum -- all are contributing to a REIT-like orgy.

George Bernard Shaw and Yogi Berra had it right: It feels like déjà vu all over again.

Fool me once, shame on you; fool me twice, shame on me.