The Most Overvalued Yield Play on the Market

Real Estate Investment Trusts (REITs) have certainly delivered in spades the past few years.

The sector has been a godsend for yield seekers; the 3.5% average yield for an index of equity REITS is more than double the 1.5% payout on a 10-year U.S. Treasury. No wonder REIT exchange traded funds (ETFs) and mutual funds have net inflows this year of nearly $7 billion according to Morningstar.

Wilshire US Real Estate Investment Trust Total Market Index Chart

Wilshire US Real Estate Investment Trust Total Market Index data by YCharts

That’s a pretty significant chunk of change when you consider that folks who study asset allocation optimization typically suggest this alternative asset class be limited to just 5% to 10% of a well-diversified portfolio.

And the analytical folks at Morningstar have a bit of a warning for yield hungry investors flocking into REITs. Heather Brilliant, vice president of global equity and credit research at Morningstar recently pegged REITS as “our single-most overvalued sector right now.”

The PE ratio for the benchmark S&P 500 index is 13. The MSCI REIT index has a 66 PE. That’s not a typo. The top three holdings in the $13.5 billion Vanguard REIT ETF are Simon Property Group (SPG), Public Storage (PSA) and Equity Residential (EQR) aren’t screaming “cheap,” as seen by their PE ratios.

SPG PE Ratio Chart

SPG PE Ratio data by YCharts

Not only are valuations high today, keep in mind that REITS get pressured in a rising rate environment. Moreover, the one chart every REIT investor should check out is how the REIT market did during the most critical stretch of the financial crisis.

Wilshire US Real Estate Investment Trust Total Market Index Chart

Wilshire US Real Estate Investment Trust Total Market Index data by YCharts

If you’ve been seduced into REITs the past few years for their juicy yields, consider yourself forewarned.

Read more articles about: Investing Ideas  

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