REITs Off to Slow Start in 2009

by: Avi Morris

REITs have declined in 2009 (following the sudden sell-off in late 2008), matching the sharp decline for the Dow. This decline should have been less because of the high yields available on REITs. Other high yielding securities (i.e. MLPs & junk bond funds) have had an up year in 2009, those high yields have been attracting investors.

Even with their high yields (double digit yields are common), REITs are not attracting buyers. Their business model is a good one because they own hard assets, land & property. However as the recession takes hold, their problems are increasing.

Dividends are the basis for their valuations, but the dividend models might change in 2009. Many REITs have excellent track records of paying & increasing dividends. Now REITs are facing cash squeezes. Rent will decrease when renters fail to pay rent. The unemployment rate is at its highest level in many years and will probably continue to rise before coming down. Retail stores have failed or will fail, their rents will be lost. Other large chains indicated some of their stores will be closed. Those chains will have to buy out leases, but that still hurts store owners, plus adjacent stores will suffer from a loss of traffic endangering those rents. Meanwhile property owners have obligations which must be paid; interest is a leading expense.

REITs are looking for ways to help get through these difficult times. Cash dividends are somewhat discretionary, not required to be paid but necessary for many investors. REITs are testing a new idea. Stock dividends may be substituted for some or all of the dividends. On the day the idea was mentioned in a news story, the Dow Jones REIT dropped 12 points or almost 10%.

Given the tremendous problems the economy is going through, substituting stock dividends for traditional dividends may gain the interest of other companies also looking for ways to conserve cash. Even the biggest, with excellent track records of paying dividends, are being challenged. The S&P 500 Dividend Aristocrats has lost members, especially in 2008 and early 2009. Of the 7 banks in the group 4 years ago, only one remains & it's barely covering the dividend. Pfizer (NYSE:PFE) cut its dividend in half 2 weeks ago, ending a 41 year streak of higher dividends. General Electric (NYSE:GE) which appears on the brink of losing its coveted AAA credit rating has a yield over 11% indicating a high risk GE will not continue (let alone increase) its dividend. Masco (NYSE:MAS) has a 50 year track record of paying higher dividends annually which may come to an end in 2009, it's yield is 12%. There is a good chance REITs will lead a trend, rethinking cash dividends vs. stock dividends.

REITs are still good investments despite the difficulties they face. Hard assets are solid assets (and mortgages are solid liabilities). Even if a few fail, stronger ones will prevail and make it through these tough times.

This is shaping up as a very tough year for the economy and real estate. Yields on REITs will probably continue at historically high levels, maybe even higher if stock prices sink further. Double digit yields are attracting the very brave, as chaos (in today's markets) brings opportunities. But the best strategy for REIT investment might be to await developments. Yields are key and the possibility of substituting stock for cash dividends, if implemented, might take time for markets to adjust to. Instead, this time can be used to learn more about the industry and identify the strongest which will prosper.

I started investing in REITs about 10 years ago. Most investments have done well even when valued at today's depressed values. They are up in price and the shares have roughly doubled from reinvested dividends. Some have not done well, but the overall investment is up. Investing in REITs should be based on long term considerations of 5 years or more. Starting from the depressed prices of 2009, strong ones should prove very rewarding and high dividends will be a principal component of future gains.

Disclosure: no positions

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