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Apartment REITs Could Face Rentals Glut

Unsold condos will likely get dumped into the rental market.

Editor's note: This column is a special bonus for readers. It first appeared on Street Insight on Nov. 3 at 7:29 a.m. EST. To sign up for Street Insight, where you can read Kass' commentary in real time, please click here.

As I mentioned recently on Street Insight, I continue

to short the

iShares Dow Jones U.S. Real Estate

(IYR) - Get iShares U.S. Real Estate ETF Report

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.

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BRE Properties



Equity Residential

(EQR) - Get Equity Residential Report

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.

At time of publication, Kass and/or his funds were short IYR, although holdings can change at any time.

Doug Kass is general partner for two investment partnerships, Seabreeze Partners L.P. and Seabreeze Partners Short L.P. Until 1996, he was senior portfolio manager at Omega Advisors, a $4 billion investment partnership. Before that he was executive senior vice president and director of institutional equities of First Albany Corporation and JW Charles/CSG. He also was a General Partner of Glickenhaus & Co., and held various positions with Putnam Management and Kidder, Peabody. Kass received his bachelor's from Alfred University, and received a master's of business administration in finance from the University of Pennsylvania's Wharton School in 1972. He co-authored "Citibank: The Ralph Nader Report" with Nader and the Center for the Study of Responsive Law and currently serves as a guest host on CNBC's "Squawk Box." Kass appreciates your feedback;

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to send him an email.