Chaos Brings Opportunity in REITs

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 |  Includes: SPG, UDR, VNO
by: Avi Morris

Real Estate Investment Trusts (REITs) have gone through a brutal time since the economy fell off a cliff last September. The Dow Jones REIT Index tumbled 60% in the last 6 months. After the fall, the index has traded sideways around the 100 level, with very choppy trading. The recession has hit this industry hard plus there are added worries about future rental income. REITs generally own real estate, property and buildings, which has been a good business over the long run. However, going through the low portion in the cycle tests believers. This is especially true in today's markets, probably the worst for REITs since the depression.

The financial world is in turmoil, which hurts REITs deeply. They own capital assets, property and real estate, financed by mortgages and other borrowings. Rents are at risk while expenses, especially interest, have to be paid. Cash conservation is key for survival, more so than in prior recessions. In just one way to cope with the credit crisis, REITs have begun a new way of paying dividends. Already three, Simon Property (NYSE:SPG), Vornado (NYSE:VNO) and UDR (NYSE:UDR), started giving stockholders the option of receiving dividends in money or stock. Although most prefer money, those who reinvest dividends will find receiving stock to be very tax efficient. Dividend cuts are another way to conserve cash and a few have made dividend cuts.

The business model of collecting rents is becoming far riskier as the recession drags on. But REITs specializing in apartments may have more appeal (for those who don't mind playing with fire) for investment. Fannie Mae (FNM) and Freddie Mac (FRE) are providing financing to REITs which own housing, helping them ride out the recession. Also, stronger REITs will be able to purchase marked down properties at attractive prices. REITs investing in other sectors (such as business properties) will have to struggle harder to cope with tighter credit availability.

REITs able to manage debt maturities and reduce overhead will survive and prosper when the economic crisis ends. Yields for REITs are at record levels, with many at 15+%. Locking up attractive yields should provide attractive rates of return when the economy recovers. With yields this high, even a dividend cut can still provide an investor with a handsome return.