Are REITs Getting Too Expensive?

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May 14, 2013 11:23am NYSE:GRI NYSE:VNQ

reitThe incredibly low interest rate environment the Fed has provided for us has resulted in a rush to REITs to capitalize on their higher yields. REITs were originally created to give the small guy access to commercial property, but

they now include things as wide ranging as billboards and casinos – and most have paid very well. I prefer the more traditional structure of commercial and retail property.

But Paul Adornato at BMO says the easy gains are gone in REITs and from here on out any increases in REIT yields will follow the inflation rate, which is very low.

But, Adornato still likes smaller REITs that still have room to grow.

Here are two…

Retail Opportunity Investments Corp (NASDAQ:ROIC), a West Coast shopping center REIT; and one that hasn’t shifted to REIT status yet, but is expected to do so soon, Forest City Enterprises Inc Senior Note (NYSE:FCY). It has a broad mix of residential and retail property but does not pay a dividend at this time. Typically companies see a big runup in price when they shift to a REIT structure.

Smaller REITs are posting bigger gains and higher payouts – in the 4.4% to 4.9% area versus 2.8% from the Vanguard REIT index. But, a Barron’s article warned that the much slower expected growth going forward means it’s time to look elsewhere for bigger returns.

Barron’s like the idea of selling some of the bigger REITs and REIT indexes for companies with more diverse revenue sources and potential for dividend growth. The names they liked were Merck & Co., Inc. (NYSE:MRK), The Bank of Nova Scotia (TSE:BNS) – that’s one you don’t hear much about – The Boeing Company (NYSE:BA) and Honeywell International Inc. (NYSE:HON).

Their yields range from 2.1% to 4.1%, but they all have the potential for higher dividends and growth going forward that will not be tied only to the inflation rate.

REITs have had a great ride, and are a good conservative hold, but it may be time to take profits and look for better returns elsewhere, especially in the big ones.

by Steve McDonald, Investment U Research

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