Bond Yields Nip on Heels of Dividends to Pressure Rally in REITs

May 14, 2014 11:34 am ET

(For more Market Insights columns, see NI MKTINSIGHT or e- mail mregan12@bloomberg.net to receive daily in your inbox.)

May 14 (Bloomberg) -- Some wise person, probably a Realtor, once said that real estate is always a good investment because they’re not making any more of it. Another wise person, probably not a Realtor, once said to ignore that original wise person when the property market crashed a few years ago.

That first wise person has an audience again, however. You can see the evidence not only in the reported $4.7 billion bid being prepared for Stuyvesant Town-Peter Cooper Village complex in Manhattan, but also by looking at the best-performing stocks in the U.S. market this year: real estate firms.

The S&P 500 Real Estate Index is up 13 percent, the biggest gain among 24 industries and five times the 2014 advance in the benchmark index. This comes after the group was the only one to miss out completely on last year’s rally in U.S. stocks, ending down 1.5 percent as the S&P 500 jumped 30 percent.

Cheap money, like what’s been engineered by the Federal Reserve, helps real estate firms in two ways. First, low rates obviously make it more attractive to borrow money to buy property. Secondly, low rates make stocks that pay higher dividends more attractive.

Competition

And even while Treasury yields are near lows of the year, the competition between their returns and real estate dividends is heating up. The 21-member S&P 500 Real Estate Index pays out 2.88 percent in dividends, compared with a 10-year Treasury rate of 2.61 percent as of yesterday’s close. That’s near the narrowest spread between the two since August 2011.

For sure, there are signs that real estate companies will be able to boost dividends. The group, all but one of which is a real estate investment trust required to pay most of its income as dividends, is projected to boost earnings by 19 percent in 2014, second only to chipmakers among 24 groups.

HCP Inc. and Health Care REIT Inc. are forecast to lead the pack, with projected dividend yields of more than 5 percent over the next 12 months. As a group, the real estate dividend yield is projected to increase to 3.2 percent.

Don’t call your broker and load up on REITs just yet, however. No one is expecting that cheap money to last forever, so bond yields are projected to go up as the Fed unwinds its purchases. The average forecast of analysts surveyed by Bloomberg calls for 10-year Treasury rates to surpass the projected real estate dividend yield by the end of this year and beat the payout by about a quarter of a percentage point by the second quarter of next year.

Golf, Tennis

At the same time, the blockbuster growth in real-estate earnings is forecast to cool to 8.9 percent in 2015 and 6.4 percent in 2016. So these stocks are going to have to fall, or analysts are going to have to be proven wrong about the future path of earnings or Treasuries, for yields to stay competitive.

If you still can’t resist the real-estate bug, check out the 15th century Spanish castle up for sale in Bloomberg’s classified pages. It comes complete with an olive orchard, a vineyard, private golf course, guest houses, a beach villa and a helipad. Listing price: 20 million euros ($27.4 million.)

They’re definitely not making any more 15th century castles.