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No. of Recommendations: 4
Warren Buffett made the convincing case (to me) that equities will increase about 7% per year over the next decade.


Reits now yield about 6.5% and I expect a 3% increase in FFO, due to inflation and a little growth, giving a total return of about 9.5%. If the market is efficient this situation cannot endure.

Of course I could be wrong; maybe equities will return 10% in the future or maybe I'm overestimating REIT total returns, but let's assume that I'm right and the spread contracts. Perhaps REITs will normally sell at higher NAV premium than in the past, perhaps NAV will increase as cap rates come down, perhaps REITs will issue more stock, overbuild, and otherwise destroy value. Probably a combination of all of the above.

Maybe the present spread came about because most investors still believe that equities will return 10% over the long run and when they realize that those returns are not realistic, they will look more kindly on REITs. Then the spreads will contract. First some pundits will write more about REITs, new REIT mutual funds will be created to accommodate those new to REITs, and more stock will be issued. This might go on until the total return of REITs reaches equilbrium with equities, i.e. until REITs have an expected 7% total return. Assuming that 3% of this return is from inflation and growth, that means that the dividend will yield about 4%.

I'm not predicting, or even hoping, that the above will occur. If the REIT yield drops to 4%, intellectual klee will argue for decreasing the allocation to REITs in the klee household, whereas emotional klee will say "What, sell the REITs that gave you so much comfort and warmth during those horrible years 1n 1999-2000, that promised to take care of you in your old age. Would you sell your son?"

Please, please tell me why yields will not sink down to the 4% region so I can get sleep peacefully.


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