REIT Valuations at All Time Highs
Real estate investment trusts (REITs) are stocks that invest in real estate and mortgages. We have used them in our portfolio since our inception, and likely will always have an allocation to this asset class. Historically, REITs have had a similar risk and return profile to large-cap U.S. stocks. However, REITs have had relatively low correlation to the stock market, making them an excellent tool for portfolio diversification.
As you all know, we don’t do much market timing or tactical shifting of our portfolios. We set targets for each asset class, and commit to them over the long term. However, we will occasionally allow asset classes to fall below our target weights if they reach what we determine to be extreme valuation levels. Such is currently the case with REITs.
We have looked at a couple different valuation metrics in coming to this conclusion. The first is the income yield that REITs produce. If share prices are low, the dividend income REITs pay will be a larger percentage relative to their share price, thus providing a higher yield. If share prices are high, yields should be compressed. In the graph below, you can see that currently, REIT income yields are as low as they have been since the inception of publicly traded REITs back in 1972.
The second valuation approach we reviewed was Price to Funds From Operations (FFO). REITs don’t have traditional earnings like most stocks do, so there is no such thing as a Price to Earnings (P/E) ratio for REITs. However, Price to FFO provides similar information. We were not able to get data going back to 1972, but the graph on page 2 shows that even on a more traditional, price-based valuation basis, REITs appear to be richly valued…
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