How Are REITs Holding Up in the Credit Crunch?

How are REITs holding up in today's market? REITs have significantly outperformed other major market benchmarks, trumpets the National Association of Real Estate Investment Trusts (NAREIT) in its latest monthly update: The FTSE NAREIT All REIT Index fell by 4.14% since the start of 2008, but this compares favorably, points out NAREIT, with the Dow Jones Industrial (down 7.53%), the S&P 500 (down 9.05%), the Russell 2000 (down 10.27%), and the NASDAQ Composite (down 14.36%).

This holds true too for last week's performance, as seen in the chart below: REIT stocks outperformed, inter alia, the Dow Jones Industrial, European stocks and emerging-market stocks. However over the past 52-week period, REIT stocks were the worst performing of them all, with a loss of 22%.

NAREIT also argues that REITs provide a comparatively attractive investment vehicle for those "looking for income with relatively low risk", particularly when taking into account leverage and yield spreads. On the issue of leverage, it has this to say:

In a challenging credit market where investors worry about many companies being overleveraged, most REITs continue to be conservatively leveraged: The average leverage for equity REITs is 39.6 percent, positioning most REITs to easily finance debt that comes due, despite tight credit market conditions.

And as for spreads:

The REIT yield spread relative to 10-year U.S. Treasuries grew in February to its widest point in more than four years. For income investors looking for income with relatively low risk, REITs look very attractive... The All REIT Index posted a yield of 5.61 percent in February versus a 3.53 percent yield for Treasuries. In September 2003, REITs had a yield of 6.22 percent compared to 3.94 percent for Treasuries.

However David Gaffen of WSJ.com's marketbeat blog questions the importance of such spreads in today's credit crunch. Gaffen takes as an example 30-year debt issued by Fannie Mae (FNM) with a 6% coupon, which lately has been yielding about 5.65% (according to Guy Lebas, fixed income strategist at Janney Montgomery) compared with the 10-year Treasury’s yield of 3.64%. This is far above normal levels of between 125-150 basis points:

“The creditworthiness of this debt is extremely strong,” notes Guy Lebas, but of course, that doesn’t matter in this environment.

Regarding shares of mortgage REITs, which specialize in borrowing short-term debt to invest it in long-term mortgage securities, Gaffen reports:

Short-term markets have been full of turmoil, though, so KBW analysts downgraded shares of two REITs [Thursday] — Anworth Mortgage (ANH) and MFA Mortgage Investments (MFA) — citing “the widening in agency spreads” and “lower leverage as we believe the companies will carry more excess capital to cope with potential uncertainties in the repo market.”

The downgrade lopped 21% off Anworth Mortgage Thursday, and 12% off MFA Mortgage Investments. Another mortgage REIT, Annaly Capital Management (NLY) dropped 17% Thursday. Anworth and Annaly slipped further still Friday.

See also:
Liquidity Fears, Repo Flu Infect Agency mREITs
Mortgage REITs Rise From Ashes