REITs REVISITED

An article in the Wall Street Journal on March 31, 2010 suggested that Real Estate stocks are set to have their best quarter since 2006. The article suggested that REITs are attracting new groups of investors who normally invest in high yield junk bonds, lured by the yield. The article pointed out that investors are banking on a strong recovery in real estate in 2011. Among other things the article pointed out that many REITs that changed their dividend policy will return to the all cash dividend. The average dividend for REIT stocks was 3.4%.

Is this investor optimism supported by the facts? A yield of 3.4% is not an attractive yield from real estate when measured against the risks and can only be justified by the conviction that dividends will rise in the near 12-18 month term. That, in and of itself, may be asking too much. For most of the country, vacancies remain high with no sign that leasing activity is adequate to trigger an upward move in rental rates. Hotels continue to be plagued by relatively low occupancies so their recovery outlook should not be optimistic particularly where many businesses are curtailing travel and meetings. It is impossible to generalize about the direction of income for any specific REIT without access to their current income schedules, square foot rents and lease roll over dates. Many properties are operating on leases that are at over market rates and will be renegotiated at lower rents in the near term. Business failures have not ended so space could continue to be placed on the market. None of these risks auger well for optimism relative to increasing occupancies and rents. Before investing in any REIT it would be important tot ascertain the sustainability of the current dividend based on lease schedules.

Opinions are mixed about the future with many experts anticipating continued fall out attributable to debt problems because either properties can not be re-financed or the outstanding loan balance exceeds the value of the property. Until these issues are behind us, the recovery will remain illusive.

Many managers have raised money anticipating that there will be great buying opportunities because of the troubles of others. But, that has not yet come to pass. Strong owners (those who hold prime properties with adequate cash flow to service debt) are not wiling sellers in a down market. Lenders who have foreclosed properties face a loss and are very slow to sell without trying to re-position the properties for a more beneficial sale. Thus, the opportunities that do exist may be confined to “problem properties” (those without adequate occupancy to service debt or provide an adequate return. These types of properties are not accretive to REIT earnings.

The published statistics and reports indicating a turnaround may be reporting a “mirage”. This is a good time to be extra cautious, particularly when looking at 4.3% yields.

April 8, 2010:

After posting this piece, three articles of interest appeared in the financial press. The first one reported that office rents declined in the majority of the market areas during the first quarter of 2010. That doesn’t provide much confidence relative to forecasts of a bottom. The second article indicated that hotel revenues are down in most market areas. And, the third article discussed the probability of increasing vacancies and declining rents in shopping centers. None of this information suggests any reason for optomism relative to a real estate recovery any time soon.