REITs Off to Slow Start in 2009

REITs have declined in 2009 (following the sudden sell-off in late 2008), matching the sharp decline for the Dow. This decline should have been less because of the high yields available on REITs. Other high yielding securities (i.e. MLPs & junk bond funds) have had an up year in 2009, those high yields have been attracting investors.

Even with their high yields (double digit yields are common), REITs are not attracting buyers. Their business model is a good one because they own hard assets, land & property. However as the recession takes hold, their problems are increasing.

Dividends are the basis for their valuations, but the dividend models might change in 2009. Many REITs have excellent track records of paying & increasing dividends. Now REITs are facing cash squeezes. Rent will decrease when renters fail to pay rent. The unemployment rate is at its highest level in many years and will probably continue to rise before coming down. Retail stores have failed or will fail, their rents will be lost. Other large chains indicated some of their stores will be closed. Those chains will have to buy out leases, but that still hurts store owners, plus adjacent stores will suffer from a loss of traffic endangering those rents. Meanwhile property owners have obligations which must be paid; interest is a leading expense.

REITs are looking for ways to help get through these difficult times. Cash dividends are somewhat discretionary, not required to be paid but necessary for many investors. REITs are testing a new idea. Stock dividends may be substituted for some or all of the dividends. On the day the idea was mentioned in a news story, the Dow Jones REIT dropped 12 points or almost 10%.

Given the tremendous problems the economy is going through, substituting stock dividends for traditional dividends may gain the interest of other companies also looking for ways to conserve cash. Even the biggest, with excellent track records of paying dividends, are being challenged. The S&P 500 Dividend Aristocrats has lost members, especially in 2008 and early 2009. Of the 7 banks in the group 4 years ago, only one remains & it's barely covering the dividend. Pfizer (PFE) cut its dividend in half 2 weeks ago, ending a 41 year streak of higher dividends. General Electric (GE) which appears on the brink of losing its coveted AAA credit rating has a yield over 11% indicating a high risk GE will not continue (let alone increase) its dividend. Masco (MAS) has a 50 year track record of paying higher dividends annually which may come to an end in 2009, it's yield is 12%. There is a good chance REITs will lead a trend, rethinking cash dividends vs. stock dividends.

REITs are still good investments despite the difficulties they face. Hard assets are solid assets (and mortgages are solid liabilities). Even if a few fail, stronger ones will prevail and make it through these tough times.

This is shaping up as a very tough year for the economy and real estate. Yields on REITs will probably continue at historically high levels, maybe even higher if stock prices sink further. Double digit yields are attracting the very brave, as chaos (in today's markets) brings opportunities. But the best strategy for REIT investment might be to await developments. Yields are key and the possibility of substituting stock for cash dividends, if implemented, might take time for markets to adjust to. Instead, this time can be used to learn more about the industry and identify the strongest which will prosper.

I started investing in REITs about 10 years ago. Most investments have done well even when valued at today's depressed values. They are up in price and the shares have roughly doubled from reinvested dividends. Some have not done well, but the overall investment is up. Investing in REITs should be based on long term considerations of 5 years or more. Starting from the depressed prices of 2009, strong ones should prove very rewarding and high dividends will be a principal component of future gains.

Disclosure: no positions

Comments

[mrresponsible:]

Please give us some REIT names you would invest longterm.

Feb 10 09:50 AM

[Emerald:]

Look at Equity Residential (EQR) and AvalonBay (AVB). Both are large, well diversified apartment REIT's. Apartments are the least risky form of real estate and the one that pension funds favor the most. Note: Long EQR.

Feb 10 10:43 AM

[Urbane Gori...:]

Not sure if I agree with this. In fact, I'm not really very bullish on anything after today... (Ha!)... I had a quick look at both of these recommendations. Neither has an extremely high dividend, which I would consider to be a red flag these days and neither seems to have an excessive debt/equity ratio. In fact, If you were looking to buy a REIT right now, both dropped quite a lot today and I'd be tempted to buy ... Well, maybe for a week. You'd probably make back what they lost, which is more than the year's dividend...

If I were to buy for a longer term, I'd **make sure** that they did not have any debt to refi during the next two years at least. Not only is it common to have short term loans (Due in 6 years, amortized for 30), but the rates that they will face can be considerably higher than what they are used to paying, if they can get them.

I have read that rents are dropping in the apartment REITS. That not only makes sense when you consider that people are losing their jobs, but is commensurate with the area that I live in (Sacramento, CA).

With all the downsizing going on these days, I'd stay away from commercial, office and business REITS, as they seem to be just starting to hit the skids.

One area that might be interesting, and possibly safer would be health REITS... This would be an Obama 'health care' play. But even these might get hammered.

jegan



On Feb 10 10:43 AM Emerald wrote:

> Look at Equity Residential (seekingalpha.com/symbo...) and
> AvalonBay (seekingalpha.com/symbo...). Both are large, well
> diversified apartment REIT's. Apartments are the least risky form
> of real estate and the one that pension funds favor the most. Note:
> Long EQR.

Feb 10 05:22 PM

[SharonW:]

The great REIT purge begins:

Analysts Drop Apartment REITs to Underperform
by Sule Aygoren Carranza

NEW YORK CITY-Reversing the trend of the past several quarters, analysts found that multifamily REITs were the worst performers out of all asset classes, based on last week’s results. The overall sector’s stock declined by 14.3% between Monday and Friday of the past week, according to Bank of America/Merrill Lynch. While individual REITs reported varying results, all failed to meet expectations and led analysts at the company to reduce the REITs’ ratings to underperform.

The largest multifamily trust, Equity Residential, lowered its forecasted 2009 NOI growth expectation by -3.75% to -9.25% due to the growing rate of layoffs, particularly in its largest market, New York City. The Chicago-based company also dropped its FFO guidance to $2-$2.30, which is 19 cents below Merrill’s estimate. The move, relates Steve Sakwa--a research analyst with Merrill Lynch--deals a blow to the entire apartment REIT group. "We expect the group to react very poorly to this outlook." Merrill Lynch’s new NOI estimate of $2.14 assumes an NOI decline of 5.5%, versus a 3.6% drop previously anticipated.

www.globest.com/news/1...

Add to that mall REITs like Simon Properties which recently announced doing a 90% stock/10% cash dividend and office REITS like Vornado doing a similar stock/cash dividend and THAR SHE BLOWS....UP that is!

For those who rely on REIT cash dividends for income you'll find sellers of that new stock-instead-of-cash dividend.

You need a bigger horizon than 10 years to figure out what the REITS will do next. Try looking at the late 80's early 90's. Commercial real estate is the next big shoe to drop. The same issues of a belief in constantly rising real estate prices, constantly rising rents, and in some instances over-building and high debt plague the commercial group as much as the residential group.

Feb 10 09:53 PM

[{5U}:]

I noticed in your profile you invest in high yield.

Debt is the much easier investment than stocks right now. Why bother with REITs if investment grade and higher quality high yield bonds offer equity like returns without the volatility and negative fundamental head winds?

CRE also tends to lag the recession. REITS have billions of debt maturities that need to be refinanced the next few years and the only reason why the stocks are not lower is because the sector is a crowded short. Ever look at the short interest?

Feb 11 04:31 PM