Monday, May 21, 2007

REITs and Financials

A very decisive pullback in the REIT sector ought to give caution to the bulls stampeding through the financial sector. While we've seen this rotation before, the size of the REIT sector
curently is much more significant than five or ten years back. In addition, the wave of property mergers, and the financial calculus (i.r. cash returns) of real estate now makes it clear that the margin of safety in real estate investments in general (and lending in general) that much thinner. Far be it for one observer like myself to call the top in financials (or at least encouraging investors to sell on strength ). But even loooking at the major banks suggests that the ROE's discounted by the current valuations need to continue to be in the high teens (and above range through 2010). What has changed to make the risk/reward so much more problematic as we approach mid year earnings season? For one, notwithstanding the multi-weeek strength in the dollar, it is still dangerously hovering at multiyear lows at a time when it is clear the European Central Bank is popping its own property bubble. The aggressiveness of the ECB and the changing complexity of international capital flows suggests favoring long term asset reallocation to non-dollar assets (albeit cautiously at these levels). Can one explain the feverish multiyear depreciation of the $ any other way? and why are $ equity markets so complacent? I for one would suggest that the burden of proof is on the guardians of $ stability, and that attempting to buy $ assets with the hope that they will appreciate faster than the $ is depreciating is a risky proposition. As the repository of most dollar denominated assets with substantial exposure to rising long-term interest rates (currency imposed), the banking system is de-facto losing its credit worthiness and the security of its long term profit stream. Mid-single digit intermediate term returns (five years) can be obtained much easier in the bond market, with less potential loss of capital

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