How REITs Were Changed by the Recession

Includes: GGP, SKT, SPG
by: Avi Morris

Real estate trusts (REITs) have had excellent rebounds off their lows last year. After the Dow Jones REIT Index closed at 86 (on March 6, 2009), it shot up 138% by Friday (May 14). Gains were fairly steady except for a lull period in the fall and early winter. Then a second surge in the last 3 months took the index to its 203 close.

Hard assets of REITs (land and property) have generally held their values through one of the most difficult periods in American history. General Growth Properties (NYSE:GGP) was the only REIT which had to file for Chapter 11, but is finalizing plans to emerge from bankruptcy. Its stock is trading higher than other REITs which did not to file for bankruptcy and pay dividends. The REITs worked hard to get through the recession. Rental income has been under pressure from higher vacancy rates and expenses were held in check (including their #1 expense, interest). Now an economic recovery is bringing improved business results.

A major casualty of this recession has been dividends. Tanger Factory Outlet (NYSE:SKT) is the only REIT I own which has been able to increase dividends in the last 2 years and those increases were minimal. Other REITs have reduced dividends, including Simon Property (NYSE:SPG) - one of the most highly regarded REITs. Dividend yields on my REITs range between 3-5½%, substantially lower than double digit rates earned when I bought REITs over 10 years ago. REITs have been known as high yield securities, but with only moderate yields, that concept has been altered. A portion of dividends may receive favorable tax treatment (capital gains or not taxable), helping increase the after tax yield in personal accounts.

Challenges remain for REITs, the need to decrease vacancy rates and approaching a period of higher interest rates. Investment earnings come from dividends and capital appreciation, lower dividend yields will test the attraction of REITs for investors. With reduced yields, there will be a greater need for capital appreciation to earn a required rate of return. Dividends will not be able to provide all earnings as in the past. More attention must be paid to rising earnings needed to increase dividends and lift stock prices.

Disclosure: Long SPG, SKT