In an a low interest rate environment, it was not surprising to see real
estate investment trusts (REITs) move up in our ETF rankings over the past
few months. Monitoring the health of market leaders is one way to monitor the
health of the entire market. When market leaders begin to show cracks, it
tends to be negative for the general market. Since our latest ETF rankings
saw REITs drop five spots, we decided to take a closer look.
From a fundamental perspective, yield-chasing investors have pushed REIT
valuations higher. In a May 15 MarketWatch
article, Greg Brewer, executive director of research at Value Line, cautioned
REIT investors:
The industry Brewer thinks is a trap for investors now is real estate
investment trusts, which have been popular because so many people are seeking
yield, but which Brewer said have been bid up way too far, making them a bad
proposition right now. Equity Residential (EQR), Boston Properties (BXP),
AvalonBay (AVB), BRE Properties (BRE)... it's not that these companies are
bad companies - they're not - but they are pretty fully priced right now, and
as an investor, I would be concerned that I am going to get in and I am going
to get crushed.
On May 16, the REIT ETF (IYR) opened in positive territory, but
experienced selling pressure for the rest of the day. IYR closed near the low
of the session. The daily chart below shows the performance of REITs relative
to the S&P 500. Point A highlights the intraday reversal that occurred
relative to the S&P 500 on May 16. Near point B, MACD shows slowing
momentum for REITs relative to the S&P 500. MACD will experience a
"bearish cross" if the black line drops below the red line.
With loans difficult to obtain and the diminished appeal of owning a home,
apartments have been in high demand. According to an April 27 Bloomberg
story:
Real estate investors competing to buy Manhattan apartment buildings
have sent prices to record highs as rental demand surges, reducing yields on
the properties to the lowest in more than six years. The capitalization rate,
a measure of investment return that declines as prices rise, averaged 4.4
percent for Manhattan multifamily buildings in the first three months of this
year, the lowest since the third quarter of 2005, according to New York-
based data firm Real Capital Analytics Inc.
The current daily chart of IYR below shows bearish divergences between two
indicators, MACD and RSI, and price. A bearish divergence occurs when price
makes a higher high, and the indicators fail to make a higher high. The
divergences can be seen by comparing the slopes of lines A, B, and C. In this
chart, MACD has already experienced a bearish cross (black below red below -
see red arrow). The Relative strength Index (RSI) has also dropped below 50,
which indicates the "bears are in control" (near orange arrow).
With the Fed promising to keep rates low for some time, REITs may continue
to be market leaders. However, given the situation
in Europe, stretched valuations, and the recent deterioration in the
charts, REITS may not be immune to further weakness.
