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Green St HoB 09-01-06.pdf
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© 2006, Green Street Advisors, Inc. - Use of this report is subject to the Terms of Use listed on last page.
The most reliable barometer for determining when to load up or lighten up on REITs vs.
bonds/stocks is the extent to which REIT share prices exceed (fall short of) NAV.
Over
the last thirteen years,
investors who increased their REIT allocations at times when
NAV discounts were the norm and decreased their REIT allocations at times when
REITs were trading at sizable premiums have reaped excess returns.
The exhibit on
the prior page shows the results of a study in which pricing at the beginning of each
month since 1993 was categorized into one of five levels of NAV premiums/discounts.
The extent to which REITs subsequently outperformed the Vanguard Balanced Index
Fund (60% stocks/40% bonds) following times of NAV discounts and underperformed
following big NAV premiums is eye-opening. At the extreme ends, REITs have
underperformed the Balanced Fund by 15% following periods of NAV
premiums
greater
than 20%, but they’ve outperformed by 22% following periods when NAV
discounts
exceeded 10%.
Following on academic studies that show that a similar strategy has historically worked
in the world of closed-end mutual funds, we first took note of the viability of this strategy
in REITdom about six years ago.
It has continued to work well throughout this decade,
even during the period since early ’04 when other simplistic allocation tools (e.g.
comparing REIT earnings yields with yields on either stocks or bonds) have consistently
sent false alarms about excessive REIT valuation levels.
REITs have traded below their
long-term average NAV premium more than two-thirds of the time since the decade
began, and investors who heeded that buy signal have been richly rewarded.
A new twist to the analysis shows that real estate investors can take advantage of a
similar arbitrage
.
Pension funds that are currently pouring money into private real
estate vehicles at a time when REIT NAV premiums are well below their long-term
average should take heed.
Compelling evidence suggests that if buying real estate at
today’s levels is smart, buying REITs is smarter.
Total Return Difference: REITs vs. NCREIF Index*
(subsequent 24 months - annualized)
19%
12%
7%
-4%
-20%
-30%
-20%
-10%
0%
10%
20%
30%
> 10% Discount
to NAV
0 - 10% Discount
to NAV
0 - 10% Premium
to NAV
10 - 20% Premium
to NAV
> 20% Premium
to NAV
* NCREIF Propery Index, adjusted for leverage.
NCREIF is an unlevered index; our adjustment restates NCREIF
return data series based on prevailing REIT sector leverage ratios and borrow ing costs at each time period.
REIT NAV premiums have remained in
one of these tw o buckets over the last
18 months.
By comparing performance of the NCREIF Property Index (adjusted for leverage) with
REIT performance, it is possible to address the question of whether real estate investors
should increase allocations to REITs when they trade at discounts and/or decrease
allocations when REIT premiums are high.
The answer, shown in the chart above is
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