Will the REITs Rally Continue?

By Greg Sukenik

REITs have staged a nice comeback since March. Overall, equity REITs are up about 38% so far in the 2nd quarter. Year-to-date, REITS are still down about 6% and 48% over the past year. All sectors are up in the 2nd quarter, with the highest gains in lodging, regional malls, and shopping centers.

So what is driving the rally?

1) The market is up. After a rash of negative news, investors are starting to believe that the banking crisis could be nearing end -- or at least is near the beginning of the end.

2) REIT share prices were beaten down to unrealistic levels in the midst of the credit crunch -- well below even conservative estimates of NAV. Even companies with little or no near-term maturing debt were swept up in the selloff.

3) Over the past year, REITs have been proactively addressing balance sheet concerns and trying to de-lever. Through asset sales, equity issuance and even dividend cuts most REITs are raising cash any way they can to pay down debt. In addition, most companies have drastically scaled back or frozen new development starts. Investors have generally reacted positively to these steps, even though many secondary offerings are dilutive to current shareholders.

Can this rally be sustained?

From initial 1Q results, it is clear that fundamentals are declining in all property types. Job losses and consumer spending trends will not get any better in 2009 and will probably get worse. This will continue to weigh on operations, earnings and, in turn, share prices.

We expect a choppy trading environment going forward. Buy companies with stable dividends and conservative leverage. Two names we like are Mid-America (MAA) in apartments and Public Storage (PSA). Both companies have no material near-term debt rollovers and safe payouts.

Comments

[Emerald:]

I would stick with apartment REIT's like EQR and AVB that have taken care of near term debt maturities and have access to Fannie Mae funds. Stay away from hotel, office and retail as the wave is still heading to shore on them as tenanats default or demand lower rents on renewal.

May 11 05:25 PM

[Alan Young:]

Hmm... cash flow dropping as office and retail space goes empty; interest rates rising with refinancings coming up on properties that have lost book value; massive equity dilution through new offerings to raise desperately-needed cash; cash dividend payments replaced by payments in stock--which is nothing more than more dilution of existing stock. Sure, what's not to like?
I'm looking for the index to drop 20-30% in the next 2-6 months.

May 11 06:47 PM

[Michael Terry:]

Apartment REITs can fund via agencies and redeploy proceeds to repaying debt at discounts (substantial in some cases) or buying properties at higher cap rates. Playing this in midrange apartment communities such as UDR's benefits from the lower average rent (rent v buy) and no significant maturities over the next few years. Converts still look cheap relative to unsecured and equity still trades cheap at less than 8x 2009 FFO.

Another interesting sector is the single tennant retail space (occupied by Realty Income (O) and National Retail Properties (NNN)). Of these Realty Income presents opportunity through its nearly 8% dividend yield which is paid monthly (the company calls themselves the monthly dividend company). The preferred shares also pay monthly.

The ability to raise equity (admittedly to pay down banks, conveniently) and debt (see SPG's unsecured offering today) evidences the sectors ability to raise capital and, therefore, survive this downturtn. The key is looking for those companies that leaned too heavily on the CMBS market and JVs.

May 11 11:35 PM