REITs: Still Some Bargains Out There

From time to time, we check in with Zacks senior real estate investment trust [REIT] analyst Greg Sukenik, in hopes that we may able to determine a bottom in the housing market either now or in the near future. Also, are there any REIT stocks worth owning?

We keep hearing about the implosion of the residential housing market. Should we expect the same problems to develop in the REIT sector?

The answer is no. The problems in residential have somewhat spilled into the commercial property sector. Cheap and easy financing is a thing of the past, and this will continue to bring down commercial property values.

Values are coming down mostly in older, class B and C properties in smaller markets, but now we are seeing cap rates increases in A properties. The difference is that commercial properties produce cash, and thus far, cash flows in most sectors have held up reasonably well. Commercial delinquencies are still low.

REITs are generally well capitalized and have low debt levels compared to private owners, so we do not expect any large property REITs to get into liquidity problems in the current economic downturn. More highly leveraged private developers could run into problems servicing debt if commercial rents continue to drop.

How do you expect 1st quarter earnings to look?

2007 earnings growth was above 6% on companies that we cover. We are projecting about 3-5% overall FFO [funds from operations] growth for the full year 2008, so this is the range that we are looking for in the 1st quarter. This is unspectacular but steady, and good considering the current economic problems in the US.

Our projections could be overly opportunistic and we think some companies will have difficulty growing earnings in 2008. There could be some negative surprises more toward the end of the year as the dismal economic situation starts to show up in results.

Well then, which sectors would you be in 2008 and which would you avoid?

As a group, I still like apartment and health care REITs, two sectors that have outperformed in 2008 over office or retail. The housing market has not bottomed out and apartment owners should benefit as people cannot finance or are putting off home buying. People will continue to spend on healthcare even as the economy weakens, and healthcare spending will remain stable this year.

I would generally stay away from most office REITs. National office vacancies are increasing in most markets, a bad sign for office landlords who will have to lower rents to keep and attract tenants. In light of current economic conditions, many corporations are not willing to take more space. Retail is having problems as consumer spending and confidence continues to plummet, so be cautious of this sector.

How would you play the sector in 2008? Should investors lower their exposure?

Investors are looking for safety in a volatile market, and REIT yields, now about 4.5% are attractive and represent a decent spread, although narrowing, over the 10-year. So investors looking for income can find some good bargains right now.

We think problems in the credit markets will drive the 10-year higher in the next six months, and this will keep REIT share prices in check. Investors need a spread between REIT yields and the 10-year note, historically well over 100 bps. So in sum, we would stay in the REIT space for good income, but stick with the sectors that make the most sense in a recessionary environment.

What about M&A activity? Will this pick up in the next six months?

M&A activity has been slow as it is now very difficult to finance large real estate deals. With recent increases in share prices, buyouts are even more difficult. We do not expect much if any M&A activity in the next six months. One company that was for sale, Maguire Properties (MPG), a company with A type assets in some of the best office markets in the country, could not find a buyer, which is a sign of the times. In this environment without cheap and easy debt, buyers cannot pay the exorbitant prices that we were seeing a few years back.

Do you have any specific stock recommendations for us?

In the apartment sector, I like UDR (UDR) and Mid-America (MAA), two companies that have low comparative valuations, steady performance, and above average yields. I still like Public Storage (PSA), the dominant self-storage operator that continues to perform well. The company has a strong balance sheet and is in a sector that should hold up reasonably well this year. On the negative side, stay away from mortgage REITs, including RAIT Financial (RAS). The company's financing sources have dried up, the dividend will be cut dramatically, and the environment for mortgage companies will not improve in the next six months.

Greg Sukenik is a senior analyst covering the REIT market for Zacks Equity Research.

Comments

[stretcho44]

This article is Greg Sukenik interviewing Greg Sukenik. The fact that Greg Sukenik was the author of his own interview makes everything in this posting suspect.

The Zacks ratings Greg published in March for RAS said he expected RAS to earn $1.30 for 2008. This means he expected they will be paying 90% of the $1.30 or $1.17 this year in dividends. At the current RAS $7.50 price, that is a dividend yield of 15.6% for the year. The $5.00 2008 target he set for RAS would imply a dividend yield of 23.4%.If RAS performs like CEO David Cohen has said several times, RAS would continue the dividend at $1.84. At $1.84, the dividend yield for a $7.50 stock price would be 23% and at your $5.00 target would be 36%.

If RAS makes the $214M in fees Cohen estimated, the dividend would be higher than the $1.84.

If management numbers were met, buyers today would get a 23% return. If your much worse forecast happens, then the 15% dividend yield seems like a pretty good for the 6 months.

Greg also forgot to add a stock position disclosure to the end of the interview.

[sbgicon]

Why are you assuming a dividend cut on RAIT when management is not? I would be very interested in any data you have that backs this assumption, or how you have arrived at your targets with reasoning.

[stretcho44]

Greg Sukenik does not even need to attend RAIT Earnings Call to get his data. The only Earnings Call that I could see that he has ever attended is IRETS call at the end of February. From the Q&A at the IRETS meeting, it did not seem like he had read the hand out material. IRETS has traded between $9.00 and $11.00 for the last 5 years and is yields 6.5%. I would be curious why he chose this company of all companies having conference calls. It may explain why there are so many errors in his reports.

[Tack]

All negative RAS opinions turned to fodder by Q1 report today. See biz.yahoo.com/bw/08050...

[F. H.Hartford]

Maybe "Seeking Alpha" should have waited for the Omega. Lets see now, $0.52 X 4 = $2.08 divided by $7.70 X 100 = 27%. Not bad even at twice the price???
:)