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Re: Including REITS in Portfolio
Old 01-10-2004, 08:45 PM   #21
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Re: Including REITS in Portfolio

A few more thoughts on REIT valuation. These are just my observations, and I claim no great insight on the subject.

REIT valuation is heavily tied to payout rates, and payout rates are considered good or bad relative to the interest rates. Rising interest rates will lower valuations, but not by the degree bonds are affected because of the underlying assets and of the effect inflation will have on rents (assuming interest rates and inflation stay correlated).

A counterbalance is that both residential and commercial vacancy rates are high right now. I just got a Denver newsletter by one of the real estate brokerages with rent survey information. The vacancy rate for multifamily housing has dropped from a high of 13% early last year to 11.2%. This should drop as the economy improves and that will create an increase in cash payouts of REITs, which will help offset the effect of raising interest rates. Commercial vacancy rates have much more room for improvement.

So, I guess I would agree with Ted, Cutthroat, and Swedroe, about knowing what I don't know about how any particular asset class will perform.

My particular real estate investment is $250k equity in a 20 unit apartment building that I manage. I feel it will give me an inflation adjusted income stream, I have a fixed 5 year mortgage, and pay a residental manager and maintenance person to do most of the work, although I do some myself to cut costs. I think real estate is a good investment to diversify with, but just have an adversion to using REITs as I feel they have been bid up by the stock market relative to individual properties. I also own 2% of a shopping center via a local real estate company. Not really diversified enough, but these are my higher risk/reward investments. I feel the ability to do hands on management mitigates the risk somewhat, or at least allows me to transform some of the monetary risk to a time cost if need be.

Wayne
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Re: Including REITS in Portfolio
Old 01-10-2004, 09:04 PM   #22
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Re: Including REITS in Portfolio

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I think real estate is a good investment to diversify with, but just have an adversion to using REITs as I feel they have been bid up by the stock market relative to individual properties.
I think this is a healthy aversion. REITs are strange animals. You can't use stock market metrics to value them, and you have to know what's inside. A REIT can be anything from a shopping mall to an interest rate arbitrage play.

Don't go by historical data -- I just don't understand how anybody could find a valid trend or correlation in historical REIT data since a REIT can be so many things, and the mix changes quickly.

I took a look at a couple of Vanguard's top REIT holdings, and they are mostly household names, but I don't understand buying a shopping mall REIT at a high price/book ratio. What's the premium for other than speculation?
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Re: Including REITS in Portfolio
Old 01-11-2004, 06:13 AM   #23
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Re: Including REITS in Portfolio

In attempting to assess the value of individual REITs, you and other investors are making the market in them efficient, so that "lazy" people like me can simply invest money in a broad-based collection of them like Vanguard's REIT index fund, knowing that we are eventually likely to make a decent return on the investment. *So keep it up, and perhaps your diligence will net you a fraction of a percent extra gain (or perhaps not), but "free riders" like me will benefit either way.

In looking at "price to book ratios," it is important to understand how book value is calculated. *The book value is simply the price at which an asset was acquired, minus depreciation as defined by the IRS. *This "depreciation" often has absolutely no relationship to the change in the fair market value of an asset.

For example, a piece of raw land may have been purchased in 1980 for $100,000, and have a value today of $10,000,000. *But its "book value" would still be $100,000. *This huge difference is possible despite the fact that the value of land can't be depreciated.

Likewise, a commercial building might have been purchased in 1980 for $100,000, and have been depreciated such that its "book value" is now, say $10,000 (the 1980 value of the land that it sits on) even though it might have a current market value of $10,000,000 or whatever. *Thus, an REIT with a high price to book value may or may not be a good value.
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Re: Including REITS in Portfolio
Old 01-11-2004, 07:08 AM   #24
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Re: Including REITS in Portfolio

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In attempting to assess the value of individual REITs, you and other investors are making the market in them efficient.
Ted, I'm impressed that you still believe in efficient markets and rational investors after the wild ride of the last six years or so.

Just as retail investors were chasing the hot money in dot-coms a few years ago, I think REITs started to gain momentum when investors started chasing yields, and that the resulting cap gains fed the fire.

I'm wary of the stock market primarily because it doesn't seem to move based on the available data. Something else is moving the market, and until some smart economist comes out with a new theory that incorporates the vast masses chasing hot money, and more vast masses taking a "disciplined" approach by ignoring all data and piling money into index funds, and the growing masses who trade based on TA of daily price movements, I have to heavily discount conventional wisdom.

But I do enjoy reading your posts
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Re: Including REITS in Portfolio
Old 01-11-2004, 07:39 AM   #25
 
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Re: Including REITS in Portfolio

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I'm wary of the stock market primarily because it doesn't seem to move based on the available data. Something else is moving the market,
This is no different than any other market. If everyone in the World decided that Diamonds were worthless pieces of rock - They would be! - The only value in them is that people want them.

If you look at the Stock Market this way, the wild rides are not that hard to understand.

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Re: Including REITS in Portfolio
Old 01-11-2004, 07:55 AM   #26
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Re: Including REITS in Portfolio

I think the diamond story is more of a marketing story. I think that the efficient stock market theory has morphed into a signal/noise story, where true value is the signal and speculation is the noise. I sort of buy that theory, but when the signal is overwhelmed by noise, that seems like as good as a timing cue as you're going to get. I'm just trying to wait for the noise to die down.
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Re: Market Efficiency
Old 01-12-2004, 04:36 AM   #27
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Re: Market Efficiency

As part of the course work for a master's degree in economics, I took some graduate courses in finance. *One of these was "portfolio management." *(I got an A in it.)

Just about everyone in academia believes that markets are "efficient," at least in the sense that there is no reliable way of "beating the market" except -- possibly -- by a little bit. *An apparent paradox is that the thing that makes markets so efficient is the efforts of millions of "active" investors to "beat" them (i.e., "beat" each other)!

My father was a stock broker and would probably be happier if I were a drug addict than an advocate of efficient markets. *The difference in outlook between financial academics and financial products salesmen is illustrated by this story that I first heard from the professor of the above mentioned portfolio management class.

A stock broker and a finance professor were walking down the street together when the broker spotted a piece of green paper laying on the sidewalk ahead of them. *"That looks like a 20 dollar bill" said the broker. *"It can't be," said the professor. "If it were, somebody would have already picked it up." *:-/

My own belief is that all assets within an asset class are, for practical purposes, always "fairly valued" with respect to each other.

Asset classes do experience temporary periods of distorted valuation relative to each other, but over the long term tend to "revert to the mean" performance that is fundamental for that asset class. *John Bogle wrote an excellent paper -- understandable by intelligent non-academics -- on the way that various sub-classes of stocks tend to do this over time.

There are ways of identifying this distortion in relative valuation between asset classes, and I used to think that it was possible to profit from them, but my personal experience proved otherwise. *Based on "simple" financial logic rather than sophisticated mathematical theory, I concluded that by reallocating assets, it is possible to reduce the volatility of a portfolio's value, but not to enhance its long-term return. *So for people who are accumulating wealth, portfolio rebalancing may be psychologically comforting but won't really affect their long-term wealth. *On the other hand, for people who are drawing down their assets, as in retirement, portfolio rebalancing will substantially reduce their chances of prematurely depleting their wealth.


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Re: Including REITS in Portfolio
Old 01-12-2004, 05:51 AM   #28
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Re: Including REITS in Portfolio

I agree with Ted - in that REITs - provided you keep your asset allocation up can help prevent portfolio depletion in the withdrawal phase. But I can't find where I filed the efficient frontier curve/research article to give details - the gist was 10-20% damped SD but overall portfolio return stayed roughly the same as stock/bond curve.

I'm at 13% Vg. REIT index in my overall IRA portfolio - mainly due to recent several yrs. - at close 20% it will be necessary to reallocate - also below 10% but I don't want to think about that.
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