By Barry Vinocur

No one argues that REITs represent the sort of bargain today that they did in mid-December 1999 when a Wall Street Journal article highlighting a stock tip (First Industrial Realty Trust) found in a wallet auctioned for charity by Warren Buffett marked the beginning of what is perhaps the longest (and strongest) REIT bull market on record. However, debate over whether REITs are too dear, just right, or perhaps a tad on the cheap side has been the topic du jour in REITland for sometime.

Those who argue REITs are too dear tick off a number of metrics, all of which leave no question that the stocks are indeed trading at peak FFO/AFFO multiples; narrow spreads to Treasuries; as well as hefty premiums to NAVs.

However, while REIT multiples may indeed appear stratospheric by historic standards; it's important not to lose sight of a number of important facts. First, modern REIT era history is oh so brief. While attempts to rationalize apparently lofty valuations are all too common as well as potentially dangerous, it strains credulity to suggest that those companies that have delivered consistent sector-leading earnings and dividend growth rates don't merit a higher multiple or NAV premium today than they did at the last REIT market peak, prior to the 1998–1999 REIT bear market.

One must also ask if equity returns are significantly lower over the next 10 to 15 years, should REITs, which have outperformed the broad market long-term, be re-priced to reflect current market realities? Those facts include the stocks' stable cash flows, desirable dividend track record (increasingly important as the population ages), diversification potential, as well as the sector's maturation, including that the stocks are far more widely held today than at anytime in their nearly 45-year history.

Moreover, while REITs may appear dear looking at multiples relative to the broad market, Treasury spreads, etc.; they do not appear so relative to private market values, or NAV. In fact, we have pressed the case in our publications for the past couple of years that generally speaking, published NAVs are low. We haven't been alone in arguing this point.

"The Great NAV Debate" as we have referred to it turns on whether one should use "current" cap rates or "long-term" cap rates when calculating NAVs. We understand the reluctance of some to lower the cap rates they use to calculate NAVs because of their belief that the dramatic cap rate decreases of the past few years have been driven primarily by the historic decline in interest rates and therefore are likely to reverse as rates rise. Each time we have the discussion we come back to the fact that the generally accepted definition of NAV (for at least the roughly 20 years I have followed this sector) has been (with appropriate adjustments) the current underlying value of a company's real estate. Since cap rates are de facto (or should be) a forward-looking metric; NAVs should reflect all currently available information. If six months, a year, or two years down the road, cap rates shift as a result of interest rate changes (or whatever), NAVs would require tweaking, if not a wholesale adjustment.

Put simply, the wide gulf between buy-side/private market NAVs and published NAVs is too large, and the data supporting higher NAVs too numerous (including the prices paid for a long list of REITs by other REITs, as well as others) to justify redefining NAVs to incorporate prejudices—no matter how convincingly argued—about potential future valuations.

As one market veteran put it recently, "The only thing more dangerous than thinking it's different this time is thinking that it's always and forever the same."