Yes, yes, I know.  It's the end of the world.  Bread lines, Okies trekking West, 25% unemployment and droughts are all coming back. 

Which is why REITs have gotten insane again, only this time on the downside.  The Real Estate iShares, ticker IYR, closed today at $25.

Now take a look at the ProShares UltraShort Real Estate fund, ticker SRS, which I used to own and sold at $110-$140, and would be quite wealthy had I kept my position.  Today it closed at $259.

And look at the counterpart, the long version of the ProShares Ultra Real Estate ETF, ticker URE, which closed at $3 and change.

Back in May of last year, I noted how stupid valuations had become on the REITs.  I wrote

Let me start by thanking the buyers of the REIT ETF, ticker IYR, of which I own long-dated puts.  Today, they bid it up, as they did yesterday in a Pavlovian manner on news that Archstone-Smith will be taken private.  Hopefully, the buyers will keep bidding up REITs so I can add to my short position.

25.2x 2006 earnings
28.4x 2007 estimates
26.1x 2008 estimates

compared to S&P 500 (excluding financials) multiples of

20.1x 2006 earnings
17.8x 2007 estimates
15.8x 2008 estimates

Thus, REITs are trading at premiums of 25% on 2006 earnings, 59% on 2007 estimates and 64% on 2008 estimates. ...

REITs are trading at a 50% premium to stocks based on FFO!  Considering that REITs used to trade at 7x-9x FFO a few years back before everyone went ga-ga over real estate, I would guess that this spread is as wide as it has ever been. ...

The market-weighted dividend on the 118 REITs is currently 4.3%.  (It is 2.9% trailing for the IYR and 3.1% forward.)  However, REIT dividend yields used to trade within a range of 6%-10%.  Also, since REITs pay out about 80% of their cash flow in dividends, the quick thumbnail calculation for cash available for dividends is 5.3% (4.3%/0.8) whereas this same calculation for the market (this time including financials) given a 30% payout ratio yields 6.0%.  So REITs, which have an inherently lower rate of organic growth than stocks, also yield less when using cash available for distribution. 

Lastly on valuation, complexes such as apartments and strip malls in suburbs are being purchased with an assumed cap rate - that is "capitalization" rate, similar to an internal rate of return - of 4%-5%, below the cost of financing.  For prime properties, the rate is lower still. Free cash flow yield is often even lower.   Thus, to merely break even, rents are going to have to go way up.  Frankly, as an investment, I think that's nuts.  I'll take a 5.25% T-bill rate, thank you very much. 

Let us look at what REITs are valued at today

8.7x 2008 earnings
11.5x 2009 earnings

Dividend yield of the REIT components of the Russell 3000, 15.1%
Funds from operation difference relative to the S&P 500, -27%

The REIT price to earnings ratio has fallen by 69%, the REIT dividend yield has risen by 10.8%, while FFO relative to the market has fallen from a 64% premium to a 27% discount, a swing of 91%.

Like I said last May

This time, the insanity is on the downside. 

I expect the selling to continue, at least in the near-term given the ridiculous prices being seen in the CMBS market, which I believe is being driven by de-leveraging and technical selling. 

I am planning to be a buyer of the IYR below $20, or its leveraged counterpart, the URE.

I hope it gets there.

Man, the market is stupid sometimes.