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Author: Reitnut Big red star, 1000 posts Top Favorite Fools Feste Award Nominee! Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 77239  
Subject: Re: REITs vs REIT preferreds? Date: 2/18/2013 8:05 PM
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A really interestng investment choice today in REIT world is between REIT commons, REIT pfds and REIT bonds.

I do not own REIT bonds as, after looking at the rates at which most REITs can issue secured and unsecured notes and bonds today, e.g., around 4%, they are not appealing to me. Yes, they are safer than either of the other two types of REIT investments, but their current yields and yields to maturity, even for long dated credit, doesn't appear to offer enough return to offset the risk of a future spike in inflation and bond yields.

REIT pfds do not offer the kinds of returns they did even as recently as one year ago. Yields have steadily declined, similar to what we've seen in the bond markets across the entire quality spectrum. That said, there is atill a valid argument that can be made that a yield on a good quality REIT pfd of somewhere in the high-5% zone is reasonably attractive - particularly vs. Baa-rated bonds that now yield somewhere in the mid-4% range. And the yield spread over 10-year Treasury notes, at close to 400 bps, is not out of line with historical metrics.

There is no doubt that REIT pfd prices will deteriorate in the event of a general increase in bond yields. This is a risk common to all holders of credit beyond very short-term maturities. But we should keep in mind that a general increase in bond yields is likely to be caused by a more rapidly-expanding US economy, which is good for CRE owners such as REITs, and which would reduce the risk of dividend default on REIT pfds. So, I think, some of the upward pressure on REIT pfd yields would be offset by the perception of less risk.

REIT common stocks may be the best choice of all three, as long as the investor isn't expecting an economic recession here in the US. Some argue that REITs are expensive today, but I differ from that view. They are trading at modest NAV premiums, generally, and there are no signs that CRE prices are about to decline (in the absence of a significant spike in bond yields or a new recession). Under these conditions, and given the low interest rates and bond yields that now prevail, along with a slow "new normal" recovery, I don't see a large near-term looming threat to CRE values or to REIT stock prices.

If AFFOs can grow at even 4% annually, on average, capital appreciation of 4% (assuming no change in NAVs or P/AFFO multiples) plus a dividend yield of close to 4% can provide average annual total returns of close to 8% over the next few years, with greater liquidity than REIT pfds and somewhat less price risk in the event of rising interest rates.

I have been slowly and methodically increasing my commitment to REIT common stocks when my REIT pfds are called, or when a YTFC gets into the mid-low 4% zone. I realize I am taking on a bit more risk of recession in doing this, but recent economic indicators provide a bit of comfort.

There is rarely a free lunch in the investment world, and thus no asset class offers high returns with near-zero risk. I think the best strategy for most investors is to diversify, own some of each asset class, and tailor the asset mix to one's financial objectives and tolerance for risk. I also think that Woody Hayes' dictum of "three yards and a cloud of dust" still makes sense for most investors.

Ralph
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