I bought VNQ in December 2008 at 34.50, and my real-world position is up 45% since then.  Stupid me, once again I make a nice real-world pick and then neglect to write a ProofTrader coverage, and so my PT Score suffers.  Live and learn.  (Special note for Josh:  I bought F at $1.)  As such, this is the second installment in my series entitled, The Stupidest Coverage Ever, the moral of which is that you deprive yourself of your own research info AND a good PT Score if you don't document why you bought something at the time of purchase.

 In this case, I do remember why I bought VNQ in December 2008.  If you're like me, then you pay attention to the real estate market.  Not compulsively, per se, because that can be maddening unless you are a flipper.  I do own some investment real estate and hope to buy more soon, but for the most part I am in it for the long haul.  As such, I receive a varied array of MLS New Listing Alerts in my email inbox, and I usually offer a cursory glance at them before hitting the delete key every day.  The sediment from these emails has built up in my mind over the past 7-8 years in the form of a Flash chart indelibly imprinted on the retina of my subconscious mind.  At the time I bought VNQ, I thought we had seen the worst of the true housing slump.  I specifically say "true" housing slump because I am talking about the house prices that sane, solvent, stationary individuals and corporations will accept for the real estate they own.  (I believe the doom & gloom numbers have been exacerbated by short sales and bankruptcies, and while their quantities do matter, the specific prices should be weighted as lesser values in true market value.  But that is a rant for another day.)

According to Google Finance, VNQ is "designed to track the performance of the MSCI US REIT Index, a benchmark of United States property trusts that covers about two-thirds of the value of the entire United States real estate investment trust (REIT) market."  In my opinion, this causes VNQ to behave as the disaffected, mopey offspring of the stock and real estate markets.  The nice thing about this is that since it's an index of businesses, then we can use the asset values of those businesses (existing property values) as a leading indicator to track the stock.  Usually when comparing real estate to the stock market, investors focus on housing starts and manufacturing, but in this case, we can use "true" value of existing home sales as the crystal ball.

Indeed, if you look at a five year chart of VNQ vs the S&P you can see the REIT index rise throughout the housing boom and the beginning of the 2006 bull market.  But then it does something peculiar.  It hits a top in the midst of the bull stock market in Q1'07, but just lags behind the top of the real estate market which you may recall occurred in Q4'06.  Now, have a look at a close-up of the 2008 market crash and you can clearly see VNQ once again lagging the major event.  In December 2008, I noticed that some of the local non-bank-owned existing home sales had been ever-so-slightly rising for a few months.  I figured that it was close to the bottom for both markets, and was pretty much right.

More recently, I've noticed some subtle but significant changes in the behavior of existing home sellers.  Just six months ago, the market was still flooded with short sales by banks that, as I pointed out in a wildly successful coverage of Citigroup last year,  had very little to lose by dumping assets they basically received for free.  Just the other day, however, I began to notice something different about the most recent fire sales popping up on the market.  They are still priced to sell, but they are no longer true short sales.  The MLS listings might say "bank owned short sale" to entice buyers, but anyone can go to the tax records and see that the property is being sold for a profit.  This is a new trend as of just the past couple months.

I should also note some other peculiarities of the real estate as a growth business.  The left side of the balance sheet of any given REIT may be dominated by real estate prices, with positive correlation between prices and value, but the bottom line can also be impacted positively by depressed prices.  This is because a wily REIT can add cheaply to its position during a housing bust and optimize future cash flows by locking in ultra low financing and therefore lower overhead for many years to come.  Good REITs should be rewarded by investors for this.  However, along those same lines, I've been burned in the past by investing in individual REITs whose management can be described as anything but wily.  That is why I gravitated toward VNQ, which represents the collective wisdom of the industry.

Potential problems with this pick?  Well, I've already established that there are two forces that move VNQ: the stock market and the true value of the real estate market.  Commercial real estate in particular  still has a recovery left in it, so I think that holds some fuel in reserve for VNQ's future, even if there is a sputter in the overall housing market.  The bigger concern is a choppy Summer in the stock market.  But fortunately, as discussed above, any major movement in the stock market will be buffered in VNQ and will give you enough time to exit your position without taking too big of a loss.  Lastly, one of the lesser known components of the index could experience a major event and escape our notice.  So, keep in mind that VNQ represents Diversified, Industrial, Mortgage, Office,  Residential, Retail, and Specialized REITs (PDF reference), and as such we should pay attention to all those industries, not just housing prices.

 I do wish that I had written this coverage when I bought the security, but no I would not trade the real money I made to be able to go back and do so. :)  Here's to hoping there is much more left in this one.