Are REITs Getting Too Expensive?

Steve McDonald
by Steve McDonald, Bond Strategist

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The incredibly low interest rate environment the Fed has provided for us has resulted in a rush to REITs to capitalize on their higher yields.

REITs were originally created to give the small guy access to commercial property, but they now include things as wide ranging as billboards and casinos - and most have paid very well. I prefer the more traditional structure of commercial and retail property.

But Paul Adornato at BMO says the easy gains are gone in REITs and from here on out any increases in REIT yields will follow the inflation rate, which is very low.

But, Adornato still likes smaller REITs that still have room to grow.

Here are two...

Retail Opportunity Investments (Nasdaq: ROIC), a West Coast shopping center REIT; and one that hasn’t shifted to REIT status yet, but is expected to do so soon, Forest City Enterprises (NYSE: FCY). It has a broad mix of residential and retail property but does not pay a dividend at this time. Typically companies see a big runup in price when they shift to a REIT structure.

Smaller REITs are posting bigger gains and higher payouts - in the 4.4% to 4.9% area versus 2.8% from the Vanguard REIT index. But, a Barron’s article warned that the much slower expected growth going forward means it’s time to look elsewhere for bigger returns.

Barron’s like the idea of selling some of the bigger REITs and REIT indexes for companies with more diverse revenue sources and potential for dividend growth. The names they liked were Merck (NYSE: MRK), Bank of Nova Scotia (NYSE: BNS) - that’s one you don’t hear much about - Boeing (NYSE: BA) and Honeywell International (NYSE: HON).

Their yields range from 2.1% to 4.1%, but they all have the potential for higher dividends and growth going forward that will not be tied only to the inflation rate.

REITs have had a great ride, and are a good conservative hold, but it may be time to take profits and look for better returns elsewhere, especially in the big ones.

The Dogs of the... Nasdaq?

Big winners wait to move until after the Nasdaq kicks them off the [Nasdaq 100] index.

A MarketWatch article this past week stated that the stocks the Nasdaq kicked out of the index at the end of 2012 are outperforming the ones that were added by more than 100%.

Ryan Detrick of Schaeffer Investment Research said in the article that investors are obsessed with previous winners and are ignoring the laggards.

According to Detrick, the average return of the stocks booted from the index after four months is 26.9% and the average for the new listings is 13.3%. And 82% of the dropped companies reported positive returns.

The numbers indicate this trend goes back as far as 1995!

One of the biggest surprises was Netflix (Nasdaq: NFLX). It is up 137% since it was cut by the Nasdaq and analysts are looking for another 20% from it this year.

Another bounced stock, Green Mountain Coffee Roasters (Nasdaq: GMCR), not only didn’t get a boost from being listed on the exchange, but it has run up since being dropped by the exchange and has run 39% just this year.

Obviously there are some stocks that have not done as well after leaving the Nasdaq, so you can’t use this as a blanket technique, but the lesson here is to not get hung up on the big winners and to look for low prices and low expectations. (Stick to the fundamentals!)

The Nasdaq dogs! Take a look at this one...

The “Slap in the Face” Award: Easy Money Edition

The “Slap in the Face” Award this week goes to all those folks who inherit a mountain of cash.

A recent Barron’s article stated that 90% of inherited money vaporizes in three generations. It seems the recipients are rarely prepared for the responsibility and squander it.

Take the heirs of the Vanderbilt fortune. Commodore Vanderbilt amassed $100 billion in today’s money. At a recent Vanderbilt family reunion there wasn’t one millionaire, not one.

Barbara Woolworth Hutton, the heiress of the Woolworth fortune, blew through a half a billion dollars in today’s money and died with just $3,500 to her name.

Very few are prepared for the responsibility of so much money.

One of the better stories in the article was about an heir to a New England banking fortune who thought it was normal to fly to summer camp in one of his father’s amphibious airplanes.

And this guy wasn’t prepared for the real world? I’m stunned.

Jamie Johnson, one of the heirs of the Johnson & Johnson money, said he was completely unaware of how much money his family had until a fourth-grade classmate read a Forbes article to his class about how much money his family had. Nice surprise!

This gets really interesting when you consider that the baby boomers stand to inherit something in the area of $7.6 trillion. The whole country has a value of $64.8 trillion.

That’s 11.7% of all the money in our system, and it will probably go the way of all the other inherited money: Right down the drain. Ouch! Or smack is probably better.

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