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Real Estate Investment Trusts

US REITs: A Mixed Bag with High Price Tags

By Roger S. Conrad, on Jun. 2, 2016

IShares Real Estate (NYSE: IYR), a popular exchange-traded fund (ETF) that offers one-stop exposure to REITs, has generated a total return of about 8 percent over the past year.

Using ETFs as a substitute for intermediate- to longer-term investments in individual stocks has several shortcomings: Diversification dilutes the best performers’ returns, while heavy weightings in names with the largest market capitalizations means that these stocks exert an outsized influence.

For example, Simon Property Group (NYSEL SPG), which accounts for almost 7 percent of iShares Real Estate’s portfolio, has generated an underwhelming total return of about 6.75 percent over the past year.

Simon Property has also grown its dividend at less than half the average rate for the REITs in our coverage universe. And the stock sports a yield that’s almost a percentage point less than the mean in our table.

Mediocrity is a high price to pay for the convenience of owning an ETF. And the cost of settling for average will probably increase over the next 12 months.

For one, REIT valuations look frothy. Simon Property Group, for example, trades at its highest price-to-book ratio since the early 1990—a high bar of expectations that leaves little room for error.

The names in our coverage universe have reported some of their strongest operating numbers in years, with the average payout ratio improving. But the average occupancy rate has declined by almost 4 percentage points from last year, while the rate of dividend growth has contracted. Many management teams have warned that revenue and dividend growth could slow over the next 12 months.

On the plus side, REITs have taken advantage of their low cost of capital to refinance debt and push back maturities.

Bottom Line: Our REIT coverage universe represents the cream of the crop, but these stocks indisputably entail more risk than they did 12 months ago. This caveat applies even more to iShares Real Estate, which features significant allocations to large-capitalization REITs that trade at stretched valuations.


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