Lipper Research Senior Analyst Don Cassidy on "Business for Breakfast" 1060 KRCN Tuesday - real Estate
Tuesday, August 9, 2005
Q. Don, you've been pretty comfortable on real estate funds right along,and they have taken quite a beating in the past few days. Comments?A. Sure. We're in one of those very painful, fast corrections.
Q. Just how bad has it been?
A. Well, if you use the Dow Jones US Real Estate Index (on which the "IYR"ETF is based), all-time new highs were made as late as last Wednesdayafternoon. From there, we've seen a drop of 9.1% in just over threetrading sessions.
Q. Wow, that's pretty nasty.
A. Right. As a context, that puts us right back where we were last Dec 31.People have earned their dividends but now have a zero net gain or loss oncapital in 2005.
Q. What has caused this? Is this the "bursting of the bubble" talked aboutfor so long?
A. No. That bubble has to do locally with single-family, and mostlyluxury-end homes in San Francisco, Miami, Las Vegas, The Hamptons, etc.Real Estate Investment Trusts (REITs) do not buy single-family homes!
Q. Then, WHAT has caused this sharp drop in REITs and therefore RE funds?
A. The very strong jobs numbers for July and the strong Q2 GDP number,combined with lots of indications the economy looks strong in Q3, whichpeople have interpreted as meaning one or two things:
- We may be in for some inflation and
- For sure, the Fed will continue raising rates, not just this weekbut longer.
Q. And why would those factors drive the prices of REITs and therefore REfunds down? Isn't real estate an inflation hedge??
A. Inflation means higher long-term rates. The Fed continuing to push theshort rate up almost certainly means the long rate will go higher at somepoint. REIT yields compete with bond yields. A dollar of REIT dividendincome is worth less to an investor if rates of interest are higher, thanwhen they are lower! So when you "capitalize" the income stream, you get alower stock price value. And the selling had some shades of panic to it onMonday.
Q. And has there been any difference in how real estate mutual funds havedone compared with closed-end real estate funds?
A. Oh, definitely! All the RE closed end funds are leveraged, which meansthat they are hurt more in two ways. First, their spread on theirborrowings is squeezed as the Fed raises rates, so that may pinch theirdividend-paying power. And second, leverage means that their net assetvalues decline (or rise) faster than a mutual fund's net asset valueswould, with the same portfolio. It looks like the market price of anaverage real estate closed end funds has fallen by about 14-15% in thesethree-plus days!
Q. Is that unprecedented?
A. Not really. We had a huge down-draft in January and another back inApril 2004 as well, that were a bit larger. But people sure look edgyabout nailing down their profits.
Q. Do you NOW think the run up in REITs and therefore REIT funds is over?
A. Let me hear the nuances of what the Fed says today and tomorrow, andthen we'll have a better sense on that. The long US bond has beendeclining pretty consistently since June 30, so that market seems to smellsomething possibly serious. It could be that the REITs have been living alittle on borrowed time, like the long bond, by going up in 2005 while theeconomy has been getting stronger.
Q. What does an investor do then?
A. You need to make a judgment about the economy and the market. You alsoneed to look at your own personal asset allocation. I have often said thatpeople probably should not have more than 10-15% total in sector funds,because they are volatile. So that means probably not more than 5% or soin real estate funds themselves. So you need to get your holdings in lineif they are out of whack.
Q. So have we seen the top -- should people sell out now?
A. The selling has been a bit severe as a short-term pattern -- probablyenlarged by the Monday effect after a painful drop late last week. WillREIT prices go straight down from here forever? Probably not. Surelythere will be some soft economic news that will cool rates off, or theselling will burn itself out. If you are still nervous, then you do someselling on such a rally.
Q. What about those famous "long-term investors"?
A. Well, if people truly are such (which means they did not panic and sellat the overall market bottom in July or October of 2002), they can probablyjust stand pat if their allocation is not too high. But if your holdingsare in tax-deferred accounts like an IRA, you have no tax excuse not totake profits if your position is still large! If you don't sell to the"sleeping point," then you will sell lower later when you lose sleep. Hopeis not a viable investment strategy!
Q. What can people buy if they need yield, and not get hurt?
A. Treasury inflation protected securities bond funds, or I-Bonds @ thebank are good way to protect principal against higher rates, I'd say.
#
Don Cassidy is a Senior Research Analyst at Lipper specializing in fund flows, exchange-traded funds, (ETFs), closed-end funds, equity fund performance, and author of Trading on Volume (McGraw-HIll).
To read more Interviews, please visit the column archive.
