Professor David Geltner of MIT’s Center for Real Estate has published an interesting analysis suggesting that REITs actually may have made thea bubble in commercial real estate prices—and the subsequent fallout from it—less severe than it otherwise would have been.
Dr. Geltner looked at what happened to the prices of two groups of properties from the end of 2000 through the second quarter of this year. The first group is properties owned by REITs; the second is properties whose owners financed their purchases with debt that was packaged into CMBS. What Geltner found was that REIT-owned properties were pushed up dramatically less than CMBS-financed properties while the bubble was inflating, and have sunk dramatically less as it burst.
REIT-owned properties gained about 55% from the end of 200 through their peak in mid-2007. Over the next nine quarters they lost all of that gain, but are now up around 17% from their trough. In contrast, CMBS-financed properties inflated by about 90% and were still being bid up through mid-2008, a year after other properties had started falling. It then took CMBS-financed properties only five quarters to lose all of their gains since 2000—and they’re still going down, to values that as of mid-2010 are already about 17% below where they were in 2000.
Lenders seem often to have applied looser underwriting criteria to loans destined for CMBS, but, according to Geltner, CMBS financing itself wasn’t the problem. Rather, the evidence appears to indicate that the private real estate investment managers who were most responsible for pushing property values into loonyland were also addicted to CMBS financing, presumably because of the lack of close scrutiny of their deals.
In contrast, REITs seem to have made better deals because they respond to a different—and more investor-friendly—set of incentives and constraints. As Geltner observes, the fact that REIT-owned properties did not “bubble up” as much as CMBS-financed properties “may reflect that many REITs during that period were culling lower quality properties or properties in tertiary cities. However, it may also reflect a fundamental characteristic of REITs as real estate investors. REITs are operating companies. They make their investment returns primarily from operations, not from trading properties. In general, the REIT industry has been very successful and compiled an enviable record of total return in the real estate investment community. Much of that return derives from income generated by REIT-held properties.” (Geltner’s emphases)
Of course, REIT investors didn’t escape the real estate downturn: REIT returns fell around 70% from January 2007 through February 2009 (although they’ve gained back most of that lost ground). Still, Professor Geltner’s evidence suggests that investors could have been hit much harder if REITs had behaved as recklessly as non-REIT investors did.
Disclosure: Author is long Vanguard REIT Index Fund and ING Real Estate Fund
Disclaimer: The opinions expressed in this post are my own and do not necessarily reflect those of the National Association of Real Estate Investment Trusts ((NAREIT)). Neither I nor NAREIT are acting as an investment advisor, investment fiduciary, broker, dealer or other market participant, nor is any offer or solicitation to buy or sell any security investment being made. This information is solely educational in nature and not intended to serve as the primary basis for any investment decision.