As REIT Recovery Continues in 2011, Two Survivors to Consider

Includes: GGP, SKT
by: Avi Morris

REITs have come through a terrible financial crisis in good shape, partially because they began retrenching before the REIT index peaked in early 2007. They sold marginal assets and cut expenses, allowing debt levels to be trimmed. In addition, low interest rates allowed them to refinance loans just as individuals did with personal mortgages. But high vacancy rates hurt badly. Revenues are reduced and empty stores or apartments make a project look less inviting than when it is fully leased. Most REITs cut dividends, some substantially, which damaged long term track records. There has been only one major Chapter XI filing, General Growth Properties (NYSE:GGP). But it emerged from bankruptcy last month with a stock price around $15 (General Motors (NYSE:GM) stockholders envy that record).

REITs have made a significant recovery from the depths of the recession. The Dow Jones REIT Index (DJR) bottomed around 85 early in 2009 and closed the year at 182. This year the recovery continued but at a slower rate. The index quickly climbed to over 200, but since then has been largely in a sideways trading zone with a high of 230:
Dec 31, 2007__255
Dec 31, 2008__150
Dec 31, 2009__182
Dec 10, 2010__217

Tanger Factory Outlet Centers (NYSE:SKT) is a REIT which has an excellent record of growth in this decade. I bought shares at less that 10 (adjusted for a 2-1 split) in 2001 and watched the stock rise to nearly 50. Including reinvested dividends, this has been a successful investment. It operates 33 factory outlet centers in 22 states totaling 8.7 million square feet of gross leasable area and provides development, leasing and management services for its outlet centers.

SKT reported Q3 funds from operations (FFO), a cash earnings figure used to set dividend rates, of 67c per share (up from 54c last year). YTD FFO was $1.78 compared to $1.99 last year. Excluding one time adjustments YTD FFO would have been $1.96, below $2.04 last year. Q3 same store net operating income increased 3.6% in Q3 and 2.4% YTD. Tenant sales increased 4.9% for the quarter and 6.3% for the last 12 months.

Rental rates on 1 million square feet of renewal leases increased 10.1% YTD and rental rates for re-leased space were up 25% YTD. The occupancy rate was 98.1% for wholly-owned properties, 2.5% higher than last year. Tenant comparable sales increased 6.3% to $349 per square foot for the 12 months ended September 30.

Finances are strong with 91% of debt at fixed interest rates. In Q3 SKT maintained a strong interest coverage ratio of 4.62 times. FFO guidance by the company for 2010 is $2.42-$2.48 (below $2.73 last year) and analysts are forecasting $2.80 in 2011. The stock, at $49.58, yields 3.1%. The dividend has been increased annually in this decade, unusual for a REIT, although most increases were modest. The dividend in 2010 was raised only a penny.

By way of contrast, Glimcher Realty Trust is a REIT which has narrowed its commercial properties, divesting most shopping centers, to concentrate on malls. Its properties are similar to SKT, but its leverage is substantially higher. FFO is projected around 75¢ in 2010 and 2011. With substantial debt, the company is marginal, but was not forced into Chapter XI and even permitted to pay dividends after it was slashed from $1.92 to 40c. Its story is a reminder that lenders recognize REITs own properties, which retain value even through difficult financial times. I bought the stock 12 years ago when the yield was over 12%. The stock is down 40% from my original purchase price but the investment has doubled from reinvested dividends.

These two stocks represent extremes. SKT, a successful REIT, saw its stock rise steadily except during the financial crisis. GRT stock rose to the high 20s, plummeted to 1 and recovered to the 8s. Because of long term values for properties, investors consider them survivors even in the most difficult times.

2011 will be another challenging year for REITs and their investors. At the beginning of this decade, 10+% dividend yields made them exciting investments. Yields typically dropped to 3-4%, partially from dividend cuts, in an investment world with low yields, indicating that superior rates of return will require more emphasis on capital gains. REIT stocks should continue to rise if 2011 is another year of recovery. That would bring a reduction in high vacancy rates, the single most important factor needed for improved earnings (and FFO) so dividends can be increased. Interest rates have just ticked up from low levels, but that will take time to negatively impact REITs.

Disclosure: I am long SKT, GRT.