Apartment REITs Could Face Rentals Glut

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As I mentioned recently on Street Insight, I continue to short the iShares Dow Jones U.S. Real Estate (IYR Quote) fund. Indeed, the apartment real estate investment trusts remain my most favored short area -- and I have yet another piece of evidence that makes me confident in my trade.

As background, what draws me to the short side is a record gap between bond yields and REIT dividends, 25 times-plus cash-flow multiples, record-high P/E ratios averaging over 42 times, premiums to net asset values, and lofty assumptions for residential and nonresidential values and rent increases (+6%) in 2007-08 that are imbedded in EBITDA and profit estimates.

The group trades at a 175% premium to the average S&P 500 P/E. As recently as late 2001, REITs traded at 11 times earnings, and valuations are, shockingly, in line with the Internet as the highest multiples in the marketplace.

And here's another nugget of why apartment REITs might be due for a tumble.

Until BRE Properties (BRE Quote) and Equity Residential(EQR Quote) mentioned it on their conference calls this week, not a soul had discussed the likelihood that many unsold condominiums would be pushed into the rental pool over the next 12 months, which would serve to restrict the heady rental increases expected and implied in the sector's growing funds from operation

Rental markets in California, Florida, New York and Virginia/Washington seem to be the most exposed to this growing risk that few are expecting.