REIT Run Goes the Distance

Return Rebalancing

Even if REITs are trading at valuations that investors have never seen before, the sector is still priced to deliver decent returns, Kirby says.

However, Kirby does note an interesting issue in the sector. A year ago, REIT stocks were priced to deliver 9% returns, he says. Now, the stocks are signaling 7.5% returns -- the lowest ever.

This is newsworthy, but it doesn't mean the sector is in trouble, he says. "They definitely are not priced to deliver the types of returns they've delivered."

But a 7.5% return still makes sense, Kirby says. REITs are riskier than corporate bonds (which yield about 6%), but probably not as risky as stocks (which are supposed to return about 9%). So a year ago, you could argue that REITs were a more compelling investment. But that doesn't mean that they're no longer a good investment.

Although Green Street uses very technical discounted cash-flow models to get the 7.5% return forecast, Kirby offers a helpful back-of-the-envelope calculation for investors.

Because REITs are "total return" vehicles, they offer dividends and capital appreciation.

The average REIT currently has a dividend yield of about 4%. Historically, unlevered real estate earnings growth lags inflation by 100 basis points. Assuming long-term inflation of 2.5% going forward, that leaves you with 1% growth. Add in 50% leverage (which most REITs have), and this boosts earnings growth to a 3% long-term return.