April was relatively uneventful for the major asset classes in terms of total returns—with one exception. REITs scored another outsized gain last month, posting a strong 7.7% total return, based on the MSCI REIT Index. Real estate securities are also far ahead of the pack for 2010 after advancing by nearly 18%, or about twice as much compared to the next-best performance for U.S. stocks in the year-to-date ranking. But with REIT valuations stretched thin, it’s getting harder to expect the real estate surge to roll on at this pace.

In the wake of the price surge in real estate recently, the yield on equity REITs fell to 3.49% as of April 29, according to data from the National Association of Real Estate Investment Trusts. That’s slightly below the 10-year Treasury’s 3.76%. Is that a sure sign that REITs are set to correct? No, although it raises the risk in the asset class.

It’s worth noting that in the past, when the equity REIT yield overall dipped below the 10-year Treasury yield, it’s signaled rough times for real estate stocks. During 2006 and 2007, the yield on the 10 year exceeded the REIT yield. After REIT prices were crushed in 2008, the yield premium over Treasuries soared, reaching more than 7 percentage points over the 10 year in early 2009.
Today, the premium has evaporated to the point that owning a risk-free Treasury produces more dividend income vs. the equity REIT market. For an asset class that’s widely embraced for income, that’s a tough nut to swallow when it comes to real estate securities. Considering that REITs are also the first-place return leader among the major asset classes over the past 12 months only adds to the risk.
That doesn’t mean REITs won’t continue to be the return leader in the months (years?) ahead. But REITs are no longer the stellar bargains they were a year ago. If your allocation to REITs is bursting on the high side relative to where it was a year ago, taking a bit of money off the real estate table looks compelling.