NEW YORK (Reuters) - Real estate stocks have been on a tear for more than a year, jumping almost 7 percent in January alone, but a recent dip suggests some are worried about too-high valuations, despite the sector’s strong fundamentals.
Last month’s jump was driven by the start of the European Central Bank’s $1 trillion-plus stimulus and a new wave of monetary easing by central banks, moves that promise to keep global interest rates low and markets awash with liquidity.
Coupled with a U.S. real estate market where demand outstrips supply in almost all markets and property types, the prospect for continued solid returns for Real Estate Investment Trusts, or REITs, is strong, investors say.
MSCI’s benchmark U.S. REIT index has soared 38.2 percent since the end of 2013 to a peak last week just shy of an all-time high set in February 2007. But the outperformance of REITs in that time points to an asset class rising too far, too fast, said Carter Worth, technical analyst at brokerage Sterne Agee in New York.
“It’s overdone,” Worth said Wednesday, adding that the sector needs to revert to its mean, or its average price over time. “At a minimum, risk-reward is not favorable. You have the potential for limited upside and plenty of downside.”
Two weeks ago, Sterne Agee singled out 80 stocks that are vulnerable to profit-taking, shorting or related selling pressure. Of those, 37 were REITs.
Driving REITs higher is demand for yield, as many fixed-income instruments deliver negative returns once inflation is accounted for. REITs are yielding about 3.2 percent, compared to a 1.9 percent dividend yield for stocks in the S&P 500.
“We know that the chase for yield is desperate. You get no money if you leave your money in the bank, no return,” Worth said.
Yet portfolio managers and others who oversee REIT portfolios say strong demand for commercial real estate and low interest rates still make the asset class extremely attractive. Flows into real estate-focused funds have been strong, with five consecutive weeks of inflows, including $550 million for the week ended Jan. 28, according to Lipper, a Thomson Reuters company. The sector has about $197 billion in total assets.
‘NEED FOR INCOME’
Rates should stay low as monetary policies around the globe are expected to remain highly accommodative, said Robert Steers, chief executive of investment manager Cohen & Steers Inc.
“The trends, the fundamentals, couldn’t be better. The need for income has never been greater,” Steers told analysts on a conference call two weeks ago.
Steven Rodriguez, a portfolio manager of American Century Investments’ $1.7 billion Real Estate fund, echoed Steers, calling REIT fundamentals “fantastic.”
An improving U.S. labor market, growing economy and low inventories are driving the demand for commercial real estate in the office, apartment and retail spaces, as well as in niche segments such as self-storage and health care, he said.
“You’ve seen demand continue to be much greater than supply,” Rodriguez said Wednesday. “So that by itself, you should expect vacancies to decrease and rents to rise.”
Historically, the supply of new U.S. real estate grows about 2 percent annually, yet the U.S. property market is now only expanding at almost half that rate, he said.
Rodriguez acknowledged REITs are trading at a 10 percent premium to their underlying value, compared to a historical average of 3 percent to 5 percent, but demand remains strong.
The two main risks to REIT performance are real estate supply accelerating to where it’s greater than demand, which Rodriguez said is not on the horizon, and rates rising in very quick fashion, which at the moment appears unlikely.
But Worth said the demand for REITs has made the market expensive. He calculated in a report that whenever the total return of the MSCI index has traded 14 percent above its 150-day moving average, a sell-off takes place “almost like clockwork.”
The index two weeks ago was almost 15 percent above that moving average, but has since narrowed as REITs have fallen 2.9 percent in the past five trading days.
Reporting by Herbert Lash; Editing by Nick Zieminski