You want to know how to make big money in the markets?
Be early.
By picking up on a trend in its infancy, you're able to position your portfolio when that trend explodes onto the front pages of the nation's business sections. Then, when mainstream investors pile in, you'll be there to sell to them.
The same goes for protecting yourself from suffering big losses. If everyone around you is losing their minds & buying everything in sight, but you perceive that conditions are starting to change, you don't want to wait. You want to sell with both hands & squirrel away your cash. Then, when the mainstream guys finally see what you saw months earlier & sell in a panic, you'll be ready to jump in & scoop up the bargains of a lifetime!
Now, it's not always easy to stay ahead of the crowd. You can be too early. Other times, you may spot what appears to be a trend only to find out you were wrong. But sometimes, all the signposts are there, & based on the risk-reward trade-off, it's far better to be early than late. I believe now may be one of those times.
My call: Jump off the REIT bandwagon!!! Here's why:
REITs go from laggards to leaders (to laggards). They are like corporate landlords. They own & operate all kinds of properties, such as apartment buildings, office property, shopping malls, & industrial warehouses. They take the income generated from rents & pay out most of it in the form of dividends to shareholders. Over the past few years, REITs have been stellar investments. Indeed, the commercial REITs kicked the snot out of the DJIA. And REITs really outperformed once you factor in dividend reinvestment!
But I think a sea of change in market sentiment will alter the rosy outlook in the REITs & signal a turning tide for them.
First, we've been experiencing a wild bout of commercial real estate takeovers recently. If you thought individual investors lost their minds flipping condos a couple years ago, you should see what the big-money commercial guys are doing now. The Blackstone Group bought a large REIT earlier this year for $39 billion. Within a few weeks, it turned around & sold many of the buildings it had just bought for more than $22 billion. Bloomberg estimated the profit from this colossal "flip" at $2 billion. That's not the kind of thing you see in the early stages of a boom. It's what you see at the tail end of a bubble!
Second, the valuations of commercial properties are getting absurd. Investment banks, pension funds, & even investors flush with cash are paying an arm, a leg, & maybe even a torso on building purchases. Prices on some cities have surpassed the $2,000-per-square foot threshold. One common valuation measure for commercial property is the capitalization rate, or "cap" rate. You compute it by dividing the net operating income a property throws off by its purchase price. Cap rates are plunging as prices soar, a sign commercial property is being richly valued. That, in turn, is a major red flag!
Third, lenders are doing the same dumb things with commercial mortgages that they did with residential mortgages! Just this week, a warning on risk in commercial mortgages had been issued. It said: "Low interest rates & an abundance of investment capital have led to heady times for buyers & sellers of office buildings, hotels & other income-producing property. Buildings have traded at record prices & loan terms have become increasingly generous, with many buyers putting little or no equity into the deals."
The warning goes on to talk about how ratings agencies that grade bonds backed by pools of commercial mortgages are seeing several warning signs in commercial deals. Among them:
"Lenders are handing out many more interest-only loans than in the past … building owners are making overly optimistic forecasts of future rent growth … & landlords aren't setting aside large enough reserves for taxes, insurance, & other costs."
Do you know: residential mortgage defaults are soaring, residential foreclosures are skyrocketing, & residential subprime lenders are going out of business left & right because they made too many high-risk residential mortgages. Yet everyone's assuming all these high-risk commercial mortgages will work out just fine!
Fourth & final, cracks are staring to appear in a key sub-sector of the REIT market; the multifamily, or apartment, industry. Speculators snapped up homes, town homes, and condos during the housing bubble in the hopes of flipping them quickly for a profit. Now, they can't sell, so they're dumping them on the rental market.
The next big leg down could be fast approaching. If you've got a stake in this segment of the housing market, I urge you to act accordingly. There is just too much excess money & credit floating around out there. It's causing a series of "rolling bubbles." Residential real estate had its turn in 2001-2005, & since about 2003, commercial real estate has been experiencing its own private mania. But a turn may finally be at hand, for all the reasons discussed.
So, if you're invested in REITs, dump them now. Valuations are at record highs while financing risk is through the roof. I will cut back my exposure in them, or think about getting out of these stocks altogether. And don't say that I never say, didn't say, or haven't say hor.
