Real estate investment trusts (REITs) have certainly been popular among investors. The FTSE Straits Times Real Estate Investment Trust Index has increased by 18% in 2019 (as of 5 July), closing at its highest level since 2007. Valuations have surged as a result, too, with the index trading at a 20% premium to book value, the most in over six years.
The REIT market barometer has eased in the past few days, though. However, the average price-to-book ratio should still be on the higher side. A question on investors’ minds currently might be: “Should I sell my REITs now to lock in my capital gains?” The quick answer is no, in my opinion. For a longer answer, read on.
Show me the income
REITs are mainly designed to be income-yielding instruments. As such, even though the price-to-book ratio may be not as exciting as before, we should focus on the distribution yield of the REIT.
If you feel the income from the REIT can still grow, and the business will be around for many years to come, then you should hold onto the REIT.
Granted, you could lose out on the capital gains now that the average P/B ratio of REITs is on the higher end. But, if you have a long-term horizon, the easing of valuation could provide an opportunity to buy more REIT units at a lower price.
Another thing to consider is that REITs could become even more overvalued due to the possible rate cut by the US Federal Reserve. If the Fed indeed cuts rates, more liquidity might flow into REITs, causing their prices to climb further.
Paying up for growth
If you have not invested in REITs at all, is now the time to enter the sector? That depends. Some REITs are way overvalued, trading at over 20% above their book values, while some are selling at P/B ratios below 1.
If you feel it is worth paying up for a particular REIT, by all means, you can purchase that REIT. As Warren Buffett once said, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Such investors could size their positions accordingly for the valuation risk and buy slowly over time. For example, you may not want a particular REIT to take up more than 5% of your portfolio, and to take advantage of any price falls, you could consider buying the REIT in three equal tranches over six months.
The Foolish takeaway
Overall, I’m still bullish about REITs, and I’m not selling any of mine. Yes, REITs may be trading on the higher end of their valuation ranges, but they still offer decent income for investors. Hence, liquidating your REIT portfolio may not be a smart move. On the other hand, I’ll not be adding any units to my REITs because they are overvalued, and I can find better growth opportunities with other companies.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.