The FAANG stocks have been dominant during the nine-year bull market. But that also means they may get more punished than the broader market when the bull dies.

Scott Crowe, the chief investment strategist at CenterSquare Investment Management in Plymouth Meeting, Pa., makes a case that based on valuations and history, commercial real estate will be a good hedge against a decline for big tech.

In an interview July 10, Crowe pointed out that valuations for real estate investment trusts have been declining relative to the entire U.S. stock market:

CenterSquare Investment Management

This chart shows the valuation (price to funds from operations, or FFO) of the NAREIT Equity REITs Index to the aggregate price-to-earnings ratio for all U.S. stocks for 20 years through the end of March. You can see that the real estate investment trusts’ relative valuation has declined significantly since peaking in early 2012.

(FFO adds depreciation and amortization back to earnings, while subtracting gains on asset sales. It is a non-GAAP figure that is used in the REIT industry to measure dividend-paying ability.)

The chart comes from CenterSquare’s recent report on REIT valuations.

Here’s a comparison of valuations for REITs against the FAANG stocks and U.S. commercial real estate as of the end of March:

The valuation bar for the FAANG group of companies — Facebook FB, -0.20% Amazon.com AMZN, -0.06% Apple AAPL, -0.69% Netflix NFLX, -0.65% and Google holding company Alphabet GOOG, -0.09% GOOGL, -0.16% — is distorted by the extremely high price-to-earnings ratios for Amazon and Netflix. To put things in better perspective, here’s a comparison of current P/E valuations for the FAANGs and the S&P 1500 real estate sector:

Except for Apple, the FAANG valuations are significantly higher than the price/FFO valuation for the real estate sector. For a further comparison, the S&P 500 Index SPX, -0.52% trades for 16.5 times earnings estimates for the next 12 months and the forward price-to-earnings ratio for the S&P 1500 Composite Index (made up of the S&P 500, the S&P 400 Mid Cap Index MID, -0.65% and the S&P 600 Small Cap Index SML, -0.45% ) is 16.6.

A comparison of FAANG and property values

This chart from CenterSquare shows the value of the FAANG companies compared to that of all U.S. commercial real estate:

As of the end of March, the FAANG stocks were worth more than half the total value of all U.S. commercial property, according to CenterSquare’s data sources.

“The flavor du jour of the equity market changes over time, but commercial real estate endures,” Crowe said.

REITs outperform after market downturns

Here’s how REITs performed following the bursting of the dot-com bubble in 2000 and the financial crisis of 2008:

Crowe did not predict when the current bull market might end, but the performance pattern following the past two prolonged periods of general decline for U.S. equities makes a sound argument for diversifying your portfolio.

Retail fears are a distraction

When asked about investors’ bias against retail property as more shopping activity moves online, Crowe said that “about one-third of the retail space in the U.S. needs to be shuttered or repurposed.”

But he also said “the retail you want to worry about,” which includes low-quality shopping malls and shopping centers, as well as big-box stores, only makes up about 1.5% of the FTSE NAREIT Equity REITs Index.

He argued that investors’ concerns about declining prospects for retail real estate was already “priced into” higher-quality REITs, including Simon Property Group SPG, -0.42% the largest holding of the AMG Managers CenterSquare Real Estate Fund MRESX, +0.10% as of May 31.

Crowe said only about 15% of the fund’s investments are in retail REITs, and gave examples of REITs the fund holds that are benefiting from technology and the evolution of consumer habits:

• The largest tenant of properties held by Prologis PLD, -0.21% is Amazon. This REIT focuses on industrial distribution — warehouses.

• Equinix EQIX, -0.05% runs data centers in the U.S., Japan and Europe, providing cloud services to more than 9,800 companies.

• Kilroy Realty KRC, +0.07% owns, develops and manages office and mixed-use real estate on the West Coast of the U.S., with a focus on the “creative office.”

Top fund holdings

Here are the top 10 holdings (of 48) of the AMG Managers CenterSquare Real Estate Fund as of May 31, with returns through July 10:

REIT Ticker Investment focus Share of fund Total return - 2018 Total return - 3 years Total return - 5 years Simon Property Group Inc. SPG, -0.42% Malls 7.4% 3% 9% 37% AvalonBay Communities Inc. AVB, +0.25% Multifamily 6.3% -1% 14% 48% Prologis Inc. PLD, -0.21% Datacenters 5.8% 4% 89% 103% Boston Properties Inc. BXP, +0.10% Office properties 5.1% -2% 10% 41% Camden Property Trust CPT, +0.18% Multifamily 3.7% 1% 37% 61% CubeSmart CUBE, -0.31% Self-storage 3.5% 14% 43% 131% Ventas Inc. VTR, +0.41% Senior housing and health care 3.4% 1% 21% 24% Alexandria Real Estate Equities Inc. ARE, +0.21% Lifescience and technology campuses 3.3% -1% 54% 120% Kilroy Realty Corp. KRC, +0.07% Office and mixed-use 3.1% 3% 21% 62% American Homes 4 Rent Class A AMH, +0.22% Single-family rental 2.8% 3% 41% N/A Source: FactSet

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