REITS With the Right Stuff

Barron’s published an article Saturday by Andrew Bary providing specific buy recommendations for publicly traded REITs. Bary interviewed Craig Leupold and Mike Kirby, president and director of research, respectively, of Green Street Advisors, the leading equity analyst firm specializing in REITs. Here are some highlights:

REITs are fairly priced, relative to investment-grade corporate bonds, but are fairly expensive versus stocks. REITs are probably at the upper end of a fair-valuation range, but not to the point that we would be alarmed.

I would agree with this, but I think the comparison with non-REIT stocks is misleading because REIT profits are at an unsustainable low while non-REIT profits are at an equally unsustainable high. So I think there will be stronger earnings growth for REITs than for non-REIT stocks, in which case it makes sense for REITs to be expensive relative to stocks when you're comparing prices as multiples of current earnings.

Malls may be an underappreciated group. Over a long span, malls have had superior growth in net operating income, or NOI, yet they rarely carry any premium to the rest of the sector.

The mall REITs are Simon Property Group (SPG), Macerich (MAC), Taubman Centers (TCO), CBL & Associates (CBL), Pennsylvania REIT (PEI), and Glimcher Realty Trust (GRT). Any investors want to share their experience with them?

We have better net-operating-income growth projections for hotels and apartments in 2011, 2012, 2013 than we do for some of the other sectors.

There are 15 apartment REITs: Equity Residential (EQR), AvalonBay (AVB), UDR (UDR), Essex Property Trust (ESS), Camden Property Trust (CPT), BRE Properties (BRE), Apartment Investment & Management (AIV), American Campus Communities (ACC), Home Properties (HME), Mid-America Apartment Communities (MAA), Post Properties (PPS), Colonial Properties Trust (CLP), Associated Estates Realty (AEC), Education Realty Trust (EDR), and Campus Crest Communities (CCG).

There are 13 hotel REITs: Host Hotels & Resorts (HST), Hospitality Properties Trust (HPT), LaSalle Hotel Properties (LHO), Diamondrock Hospitality (DRH), Sunstone Hotel Investors (SHO), Hersha Hospitality Trust (HT), Strategic Hotels & Resorts (BEE), FelCor Lodging Trust (FCH), Ashford Hospitality Trust (AHT), Chesapeake Lodging Trust (CHSP), Chatham Lodging Trust (CLDT), Supertel Hospitality (SPPR), and MHI Hospitality (MDH).

REIT investors have a habit of focusing too much on funds-from-operations yield and dividend yield and not enough on growth potential. So portfolios of high-quality REITs are usually on sale at very pedestrian prices.

I think that's exactly right: the main story for REIT investors over the next several years will be earnings growth, partly from improvement in operating fundamentals but very much also from acquisitions.

Indexing in the REIT space has historically underperformed active management because the active managers have very experienced teams that analyze 100 or so REITs. These active managers have a big informational advantage over the average uninformed investor and this has translated into superior performance over time.

I've also seen academic research drawing this same conclusion. That's interesting, because the results for non-REIT mutual funds are different: passive investing generally beats active investing outside REIT space.

Green Street specifically recommends AvalonBay (AVB), Simon Property Group (SPG), and Boston Properties (BXP). The article also discusses Vornado Realty Trust (VNO), General Growth Properties (GGP), Taubman Centers (TCO), Macerich (MAC), Kimco (KIM), Inland Real Estate (IRC), and Piedmont Office Realty Trust (PDM).

Disclosure: Author is long ING Real Estate Fund and Vanguard REIT Index 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.