Will REITs Lag Along with the Recession?

 |  Includes: ICF, IYR
by: Avi Morris

The first six months of 2009 have been a very good time for the high yield sector. They had fallen sharply in 2008, especially in Q4, when investors sold yield high yield securities to buy Treasuries. In 2009, they rebounded sharply as investors decided to accept risk in pursuit of double digit high yields.

But REITs have not shared as much as other groups (MLPs and junk bond funds) in the gains for 2009. The Dow Jones REIT Index began the year at 151, but plunged to 101 at the end of the first quarter. In Q2, the best quarter for stocks in many years, REITs climbed back to 128. REITs had a good gain in early April, but since then have been trading sideways between 120-140. After peaking early in June at roughly 140, the index has been slipping and sliding (as have many stocks). The Alerian MLP Index has a similar price pattern, but its decline from the high and subsequent recovery was more mild.

REIT securities are feeling the effects of the recession more than other high yield stocks (i.e. MLPs and junk bond funds). One large REIT has already failed after living on the edge for months. But that did not hurt other REITs. On the other side of the coin, an REIT made a token increase for its dividend to preserve its streak of higher annual dividends. However dividend cuts have been more common.

With the recession telegraphed for more than a year, REITs have had opportunity to sell assets, extend debt financing and sell stock (especially after the market recovery this year) to help prepare for tougher times ahead. REITs which own housing are working with Fannie Mae (FNE) and Freddie Mac (FRE) to refinance loans. But REITs will continue to suffer as the recession drags on. They lease property to tenants and vacancy rates are rising. At the same time they have to cope with fixed costs. Their primary cost, interest, has to be paid no matter how low their rent collections fall.

For the balance of the year, the strength of the recovery will be key for the economy and especially REITs. With unemployment continuing at high rates (probably going higher) and a reluctance of business to invest for growth, REITs are facing increased delinquency rates in their leases. More dividend reductions have to be expected.

Real Estate has an excellent long term record and those forces should continue. But the problem is getting through the recessionary period. If it drags on and the economic recovery is slow, REITs are looking at difficult times in the coming months. That seems to be what the chopping trading for the index in the last few months has been indicating. Other high yield securities (such as MLPs and junk bond funds) may also experience more selling over worries about increased headwinds that REITs are facing.

Disclosure: no positions