The Big Fade On The REIT Yield Premium

It’s been more than two years since the markets hit bottom after the financial crisis of late 2008/early 2009. What a long strange trip it’s been. It may get stranger still. But in the interest of finding some context, it’s useful to compare returns since the trough. Let’s arbitrarily call the end of February 2009 as the bottom. How have markets fared since?

The chart below compares several of the usual suspects, including my proprietary benchmark of all the major asset classes: the Global Market Index. The clear leader: REITs. The MSCI REIT Index, quite simply, has soared. Even emerging market stocks haven’t kept pace.

But the burden of leadership eventually takes a toll. Mean reversion, in other words, is usually lurking. The thought comes to mind in reviewing the strength of REITs. In absolute and relative terms, performance has been on a tear. But when we look at REIT yields, it’s easy to turn cautious. Relative to a 10-year Treasury, the traditional yield premium in REITs has evaporated lately. That’s a sign that the asset class may be headed for rough waters.

The last time REIT yields slipped below the prevailing rate on the 10-year Note during the spring of 2010, a wave of selling descended. For instance, the Vanguard REIT ETF (VNQ) was trading well above $52 a share in late April 2010. At the time, there was little or no yield premium for REITs, according to data from NAREIT. By early July, the ETF had shed nearly 20%.
Previous episodes of negative REIT yield premiums over the years have also brought lower prices. The good news is that lower prices do wonders for raising yield premiums and expected return. For example, buying REITs in late August 2010, when the yield premium had risen to a percentage point from the spring’s premium of nada, delivered tidy gains in the months ahead. Indeed, the Vanguard REIT ETF is up by a handsome 20% these days from last August.
Is the yield premium for REITs destiny? Not necessarily, but valuation can’t be denied indefinitely. It seems as though it’s a good time to rebalance your REIT allocation if it’s bursting at the seams. If not now, when?