Tuesday, May 4, 2010

The strange world of REIT ETF's

The REIT market has been on a nice run this year and again in April. It is hard to say why. If you compare REIT yields versus 10-year Treasury rates you would have to avoid. There is little yield premium versus a risk-free rates with a comparable duration.

The data on the commercial real estate market is not pretty. It is certainly one of the drivers for declining performance at smaller banks. Vacancy rates and unleased space has been increasing and the rates charged for any new tenants or renewals have been coming down.

Commercial office vacancy rates are 17.2%, the highest since the early 1990's. Regional shopping centers have rates at 8.9% the highest on record sine 2000. Strip mall vacancies are up to 10.8%. Cash flow yields for commercial real estate are also poor with little premium relative to long Treasuries. Granted REIT's have higher betas than the market, yet the fundamentals are poor.

The positive story for the REIT sector is based a stronger economy and a general loosening of credit banks. So what should dominate? A general pick-up in the economy which should be good for real estate or the current poor conditions which have not shown signs of improving. We do not want to fight the tape, but being cautious in this market may be prudent.


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