Certain Risks Abound, But REITs Still Worth Considering

Several REITs stocks that I’ve been watching continue to decline in value well below any point that seems rational. This may present an opportunity well beyond that of other companies due to the immediate payback. Many REITs now demonstrate dividend yields above 25%. A recent article at Running of the Bulls notes that REITs now look cheap.

I’m willing to acknowledge that REITs are likely cheap for good reason. In many areas, commercial real estate is following the declines in residential real estate. The sharp decline in consumer spending is hitting practically every retail company. As a result, retailers are limiting expansion plans and closing stores. The financial sector has had massive layoffs that will likely damage the office sector. Manufacturing declines in the middle of the country will likely have negative effects on the industrial sector. There are definitely risks in this sector, but certain aspects of commercial real estate make REITs worth considering.

Long-Term Leasing

Value in commercial real estate is created by long-term leases. In an anchored retail center, the anchor lease is often for 20 years or more. This can create long-term stability provided the credit of this tenant is strong. Think of a Wal-Mart (WMT) anchored center. Walmart is likely going to be in that space and able to pay rent for a long, long time. Granted, they are likely not going to be paying a great deal in rent, but they will create value for smaller tenants. Smaller tenants in anchored shopping centers will be in space for three-five years. The length of these leases will often prevent sharp drops in occupancy and rental income. Often by the time leases begin to roll, rents will have bottomed and vacancies could be on the decline.

Stabilized Properties

The bread and butter for any equity REIT is the stabilized property. These are properties that are in good locations with established tenancy and near maximum occupancy. There are often good synergies between various tenants that cause the whole to have greater value than the sum of its parts. The inverse of this strength is that REITs with large development portfolios deserve their low prices in this market. The prospects for new tenants in speculative projects is very slim in most markets.

Regional Markets

There are many regions in this country that are not experiencing the same devastation that is occurring in places like Las Vegas, Phoenix, or Florida. REITs may be available at strong, sustainable yield levels in more stable markets.

The search for equity REIT stocks should focus on a few key elements. These include the following:

• Relatively Low Leverage
• High Proportion of Stabilized Properties
• High Proportion of Properties in Stable Markets
• Good Portfolio Visibility

In many circumstances, I would rather look at smaller REITs. They may have less economies of scale in regard to management, but you can often find more regionally focused or property type specific REITs that can provide greater visibility.

Strong dividend paying stocks will provide many benefits in this downturn. The key is to focus on sustainable high yields. There are likely opportunities in REITs that will provide immediate dividend returns in this market.

Comments

[birder:]

He does have a point about yield.

2008 Nov 25 08:15 AM

[bluesmoke:]

Realty Income - "O" - fills that bill I believe. Not sexy, just consistent and under the radar.

2008 Nov 25 08:56 AM

[k45:]

Yes, Walmart anchors a strip mall...until they move a half mile down the road!

Walmart was in a busy strip center here locally but wanted to expand to a "Super Walmart". Other than a Kroger's at the opposite end, the strip is mostly empty. The parking lot would make a good place for a truck driving academy.

2008 Nov 25 09:59 AM

[Jeff:]

NNN is another great retail with very long leases and they have increased their dividend for 19 years. Down 50% so far

2008 Nov 25 02:22 PM

[Nawar Alsaadi:]

HR.UN offer good value here, I believe the unit price already reflect a possible 50% cut in the payout, while the current market cap gives ample protection in case of asset sales in a depressed market.

Thus getting an average of 14%/15% dividend (assuming a 50% cut), while waiting for the equity to appreciate back to book value $15+ seems like an excellent deal.

Finally, it is worth noting that 50% of H&R loans are non-recourse financing, thus in an event of an issue of those loans, the risk will be limited to the underlying property and not the whole company.

Regards,
Nawar

2008 Nov 26 02:37 AM

[19709:]

You are right about NNN. I have been researching REITS for several months now and picked NNN I got in at $11.30/share, representing a yield of 13.3%.


On Nov 25 02:22 PM Jeff Herman wrote:

> NNN is another great retail with very long leases and they have increased
> their dividend for 19 years. Down 50% so far

2008 Nov 28 11:46 AM