The Bloomberg North American REIT Index, a capitalization-weighted index of 129 real estate investment trusts (REIT), has lost roughly 8.5 percent of its value since mid-May.
However, even with this pullback, the average US-listed REIT trades at more than 2.3 times its book value and yields less than 3.5 percent–a frothy valuation relative to historical norms.
In addition to an improving economy, swelling institutional investment in this niche industry has contributed to the group’s big run-up. Many money managers regard REITs as a higher-yielding alternative to bonds. With interest rates at historically low levels, money has flooded into the sector; institutional ownership of some of the most popular names in the space now exceeds 90 percent. This level of institutional participation contrasts with only a decade ago, when individual investors accounted for much of the liquidity in US-listed REITs.
In recent years, institutional buying has pushed REIT valuations to levels that are difficult to justify, making the group vulnerable to a steep correction. Potential downside catalysts include the US economy stalling out or the return of higher interest rates.
Income-seeking investors will have to head north of the border to find REITs that trade at reasonable valuations.