Stephanie Martin Krewson on Investing in REITs

Includes: CSA, EGP, FRT, LHO, LPT, NNN, O
by: The Wall Street Transcript

On March 10, The Wall Street Transcript interviewed Stephanie Martin Krewson, a Senior REIT Analyst at Janney Montgomery Scott LLC. Key excerpts follow:

TWST: What do development pipelines look like?

Ms. Krewson: The REITs that have very robust development departments should continue to generate strong earnings growth, but only if they also have the balance sheet flexibility to fund their development pipelines. Out of our coverage, in 2007 Liberty Property Trust (LRY) completed their multi-year strategic reallocation during which time they sold billions of dollars of properties and redeployed those proceeds into new markets, such as Washington DC, and/or funded their development pipelines. They are in what I'd characterize as a position of strength. They have a very attractive development pipeline of office and industrial properties in their core markets (primarily up and down the East Coast).

Yet the reason that that's an advantage for them, rather than a liability, is because they have the balance sheet capacity to fund their projects. Other REITs might not be so fortunate, but once again, that's why we back Liberty's management team — for having the foresight to have made hay when the sun was shinning.

The one trend I did notice, and Liberty is a case in point, is a decrease in the number of speculative developments. Liberty decreased their guidance for development starts this year by $100 million to account for their decision to delay construction of speculative projects. They are only going to go forward with the developments where there is not a lot of risk and, the other side of that same coin, a lot of certainty in terms of their ability to get those properties leased. I think some people might view the decrease of $100 million of developments starts as a defensive position, but I view it as a smart position. You have also seen EastGroup Properties (NYSE:EGP), another name we cover, decrease their expected development starts this year for the same reason: cutting back on speculative projects.

TWST: What names are you favoring at this point beyond Liberty?

Ms. Krewson: With where prices are, we have a buy on nearly everything we cover. In terms of our coverage universe, I would highlight First Industrial Realty Trust, which I've already mentioned for its attractive current yield. Cogdell Spencer (NYSE:CSA) is a niche player in the office space. They own medical office buildings, which is a very low-risk, attractive way to take advantage of the growing demand for health care and therefore healthcare-related facilities in the US. We have a buy rating on Cogdell Spencer. Liberty Property Trust, which we've discussed already, owns more traditional high- and mid-rise office space and industrial/warehouse buildings.

Recall that we expect a consumer leg to this recession, should we have one. In that scenario, and getting back to your question about headline risk, some of the biggest headline risk is going to surround retail names whose tenants may file for bankruptcy in a recession. In our view, the mall REITs are more at risk for bad headlines because they tend to have a greater percentage of national retailers. If a national retailer gets in trouble, the cash flows at affected malls won't be materially negatively impacted. However, that situation is going to generate some negative headlines for the landlord. The average investor will perceive there to be much more risk than there actually is. So we would advise taking a more defensive approach to the retail sector by focusing on grocery-anchored shopping center landlords.

In the shopping center sector, our number one pick is Federal Realty Investment Trust (NYSE:FRT). We have a buy on that name. In the triple-net space we cover two companies that own free-standing retail buildings leased to single tenants pursuant to long-term, triple-net leases Realty Income (NYSE:O) and National Retail Properties (NYSE:NNN). (Triple-net just means the tenant, rather than the landlord, pays the operating costs associated with occupying the building, including taxes and insurance.) Triple-net REITs are the most defensive category of equity REITs because they have those long-term, more bond-like leases underpinning their cash flows.

Last but not least, two sectors we would underweight for now are hotels and apartments. Owing to the shorter duration of their leases — six to 12-month leases for apartments and day-to-day for hotels — these types of REITs are at risk for having their cash flows decline during an economic slowdown. That being said, I get calls where someone has a client and they really, really, really want to buy a hotel name. We don't have a buy on this name right now because we think hotel fundamentals in the US are declining, but we do have a neutral rating on LaSalle Hotel Properties (NYSE:LHO). If people already own a name like LaSalle, we think that even in a downturn LaSalle will outperform the average hospitality REIT. Again, we don't have a buy on it, but if someone absolutely has to get exposure to the hospitality sector that's our best idea.