Froth everywhere

Parts of the broader market have been frothy for some time now with a surprising concentration of companies with huge market caps and negative earnings.  Recently, some froth has entered the REIT space.

With the Fed’s dovish turn, capital has been pouring into REITs and this is capital that is not used to investing in REITs so most of it went straight to the ETFs and therefore was allocated in an inelastic fashion that ignores valuation.  The latest surge pushed a good number of REITs into dangerously overvalued territory.  We see 3 main categories of froth among REITs.

  • “safe” REITs. These are the large blue-chip style REITs that are the primary targets of investors looking for bond replacements in the low interest rate environment.  I have safe in quotes because the sheer overvaluation actually makes these risky investments despite the solid fundamentals.  A mere fall to fair value could cause loss of as much as 10% to 50% of principal depending on the magnitude of overvaluation.
  • Exciting REITs. This includes stuff like Innovative Industrial which is up more than 500% relating to the marijuana stock bubble.  Some of the more tech related REITs are also getting unjustifiably expensive.
  • Industrial REITs. I get that warehouses are one of the beneficiaries of the growth in e-commerce, but there are fairly low barriers to entry.  Some of the pricier industrial REITs have multiples in the 30s and that is just too much growth baked in given the lack of barriers to entry.

It has hurt us to not be involved in these frothy names as they exceeded realistic valuations, but it will be a blessing when they eventually come back down to earth.  We are fundamental analysts, not momentum chasers and valuation is the most important fundamental over the long run.

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