REITs: Past, Present and Future

REITs have been pummeled recently, like all other high yield securities. But this chaos also brings opportunities and a good time for evaluation.

The Dow Jones REIT Index was trading around par at the start of this decade. For a few years, the index was pretty much flat; most gains came from dividends. From 2003 - 2006, REITs were in their glory, rising from 150 to over 350. Then it sold off badly. During 2007 it fell, pulling back to 208 by year end. In 2008 it was steady, remaining in the mid 200s until October when it plummeted to 100 in less than 2 months. If records existed, this would probably have been the worst drop in history for REITs. The imminent economic slowdown in the US did them in.

My experience with REITs has been pretty good; many STILL have excellent long term track records. They have done quite well, even after the recent sell-off. One example is a stock I purchased exactly 10 years ago. Shares have almost doubled from reinvested dividends, the dividend has been raised every year and the stock price went from 25 to 40. The original investment tripled with much of the gain from the effects of compounding reinvested dividends.

While each stock has a different story, this is representative of the solid winners. A few were bought out at significant profits while the remaining ones are struggling their way through the financial crisis. Even those companies are paying dividends, generally at reduced levels. For speculators, the marginal ones have more than doubled from their overly depressed levels a few weeks ago. Even in this recession, they may survive and produce significant profits for buyers.

Somebody once told me that in a decade real estate has two good years, two bad years and the rest are middle kind of years. That seems to describe what happened in the last decade. Now we're going through the tough years. But these bad times will not last. A nice feature of REITs is that they (generally) own hard assets: buildings and properties. These are assets which can be touched versus service companies whose assets are people, which are difficult assets to value, let alone the fact that employees can leave suddenly. Hard assets are built to last.

The problem for those who believe in real estate is getting through this difficult period; it will be a testing time. While an economic slowdown is a major threat to REITs, some damage could be less severe than might be imagined. Owners of stores, malls and office properties will have some protection because their leases are long term. Business leases last for 5-10+ years. If a lessee fails, the lease will be a total loss to the real estate owner. But if a company only closes some of its stores and/or office properties, the real estate company should be able to collect rent for the balance of the lease (or receive a buyout payment). Apartments have short leases, typically one or two years. Apartment owners will largely be affected by unemployment rates in the areas where the apartments are located.

10 years ago, REITs with high dividends yielded 10-12%. Now the strongest REITs yield 7-10% while medium and lower rated REITs yield well into double digits. Such yields have a 1000+ point spread over the Treasury yield, bringing out yield conscious buyers into the beaten down REIT market. Chaos brings opportunities. Smart investors might want to check out beaten up REITs which don't deserve present values (with their extremely high yields) for holding until real estate markets return to the middle kind of years. When they return to traditional valuations, profits will follow.

Comments

[reader:]

High yields will only continue to occur if revenues are present. There are many reit's that have reduced their payouts (you don't name any good or bad reit's in your article), so as always "due diligence" is the operative phase.

Jan 07 09:33 AM

[SharonW:]

You also fail to mention that the loss of anchor tenants in malls frequently precipitates a loss of other tenants either through lease clauses relative to anchor tenants remaining or due to lack of traffic caused by the anchor loss.

Many of the major anchor tenant types, i.e. Macys, Sears, etc. will be closing many of their stores soon as these companies are in financially rough, rough shape.

Also, there are now multiple articles in the news on collapsing office markets as well in all the major metropolitan areas. A quick Google News search for commercial real estate tells too many sad tales. There's no reason to get into the REITS this early in the cycle. We are not, as some are predicting, bottoming in the next six months. Just watch the data coming out in the next few weeks.

Jan 07 04:54 PM

[REITIRATE:]

Sounds like the "hope they may survive" thesis. Should investors put their heads between their knees, assume the crash position, and pray the REITS "return to normal valuations?" I'll wait for a later flight, thanks...

Jan 09 05:09 PM

[RE Valuator:]

From where I sit, "normal valuations" are lower yet. Commercial RE prices bubbled with cap rates in 4-6 range in recent years. When we see 10 caps come back, I will be comfortable using the term "normal valuations".

Jan 10 09:44 AM