Wall Street hates REITs like it's 2009

By Brett Arends

BofA Securities survey shows that fund managers are staggeringly underweight in real-estate investment trusts

If real-estate investment trusts don't outperform the S&P 500 SPX from here, I'll eat a hat.

OK, so I might first get a chef to make me an edible hat. Sourdough? Spun sugar? Falafel? We'll see.

But it will still be a hat and I'll still eat it.

The reason for this optimism, or foolish confidence, is the news that Wall Street has all but given up on real-estate investment trusts, or REITs. The latest survey of the world's leading money managers shows that they have now slashed their exposure to REITs to the lowest level since 2009.

In other words, since the biggest real-estate collapse, implosion, panic and hysteria in our lifetimes.

The data from the monthly BofA Securities global fund manager survey shows that managers are now, by the standards of history, staggeringly underweight in real-estate trusts, meaning their net exposure is far below normal levels or what they consider their benchmarks.

And yet the same survey shows they are extremely bullish - some might say euphoric - about almost everything else. They are heavily overweight in stocks and commodities. They predict interest-rate cuts in the near future but no longer fear a recession.

How do these two things stack up? With difficulty.

Never mind that at the same time, house prices are at record levels, and the general public is extremely bullish on housing (as well as stocks).

Read: There's scary complacency about stocks and home prices. What it means for investors.

If the economy is going to be OK, it's hard to see how real-estate trusts don't do well.

But if the economy tanks, it's hard to see how the rest of the stock market holds up.

Real estate has its challenges. Most obviously, working from home has sparked a crisis among office REITs. Many buildings are sitting half empty. Some may end up in chapter 11. Others may be bought up for cents on the dollar.

But how big a deal should this be for us regular investors looking at REITs, or REIT funds, in our retirement plans?

Answer: Probably not much.

And how much of the bad news hitting the companies is already reflected in lower stock prices?

Answer: Plenty, if not all.

Let's start with the first point - that this shouldn't be a huge deal for those of us apt to buy REITs using mutual funds or exchange-traded funds in our 401(k) plans, IRAs and other retirement accounts.

These office REITs now account for 7% or 8% of the major REIT indexes - meaning that if you buy a REIT index fund, about 7 cents of each dollar goes into office buildings. The rest goes into warehouses and factories, hospitals and clinics, nursing homes and senior-living homes, data centers, apartment blocks, shops and shopping malls.

The days when the industry was dominated by the big office blocks are long over.

Investors looking for low-cost, broad exposure to REITs through funds face an embarrassment of riches. The Schwab U.S. REIT ETF SCHH charges 0.07% a year in fees, while the iShares Core U.S. REIT USRT and Fidelity MSCI Real Estate Index ETF FREL charge 0.08%. The Real Estate Select Sector SPDR Fund XLRE charges 0.09% and the Vanguard Real Estate ETF VNQ charges 0.12%.

If you want to buy a global fund rather than one that invests only in the U.S., the iShares Global REIT ETF REET, which is 70% invested in the U.S. and 30% overseas, charges 0.14%.

As for the second point: Those big office-building REITs are already trading at historically low levels, at least by some measures.

For instance, according to FactSet data, many now trade at much lower levels, in relation to their tangible book value per share, than their averages over the past 20 or 25 years.

Boston Properties (BXP) trades at 1.75 times tangible book, for example, compared with an average since 2000 of 2.75 times. Vornado Realty Trust (VNO) trades for 1.1 times, compared with an average of 2.75 times since its IPO 20 years ago. Kilroy Realty (KRC) trades for 0.8 times, compared with an average this millennium of 2.1 times.

It's a similar story when you look at these stocks using another well-known metric, namely share price in relation to the funds from operations, or FFO. (This is the nearest thing REITs have to the price-to-earnings ratio on regular stocks.)

According to FactSet data, all three trade for about seven times FFO from the last 12 months. That's about half the average and not far above the record lows seen in 2009.

Based on their stock prices and valuations, most of these companies now rank as midcaps or small-caps. On Wall Street, AvalonBay (AVB), the biggest apartment-block owner, is now worth three times as much as Boston Properties, the biggest office-block owner.

Vikram Malhotra, REIT analyst at Mizuho Securities, tells me the latest survey results aren't a surprise. "I would say we're probably pretty close to ... peak bearishness for REITs," he says.

Work from home caused a lot of damage among the office REITs, he says. He's seen some distressed buildings bought by vulture capitalists for little more than the value of the land they sit on. But, he adds, "work from home" isn't what it used to be. "In New York, remote work is largely over, at least in the financial and professional settings," he says. "People are back four days a week."

I guess WFHOF, or Work From Home On Friday, is the new WFH.

Malhotra says many clients have also been reluctant to invest in REITs as long as they feared a rising interest rate environment. That has traditionally been bad for REITs on Wall Street, as well as for utilities and dividend stocks, because rising rates make their income streams less valuable in comparison. When clients can put money in Treasury bills and collect 5%, it tends to take the shine off REITs, Malhotra points out.

All true. There again, this is a liquid market, which means that when an investment faces bad news or is unpopular, it drops in price. Buying low and selling high requires you to buy low - and that, alas, means buying when something is unpopular.

-Brett Arends

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05-15-24 1458ET

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