REITs Face More Challenges in This Recession

Includes: FFR, REM, VNO
by: Avi Morris

At the beginning of this decade the Dow Jones REIT Index was roughly par (100), then grew steadily to 350 at the start of 2007. For the rest of the year and until September 2008 the index slipped to the 250-300 zone. That performance in 2007-2008 was not too bad given the decline for the rest of the stock market. Beginning September 2008 the REIT index fell off a cliff, much worse than the Dow. While the Dow lost one third, the REIT Index plunged 60% from 250 to 100. REITs bounced back in the year end rally, but then sold off badly, this time to 80, at market lows in early March. REITs joined in the subsequent 2 month rally followed by sideways trading between 120-140 while the Dow was edging up followed by impressive gains in July. The REIT index remains down YTD.

REITs are high yield securities and many are tax efficient with only a portion of the dividend taxable as income or capital gains. However, they have not participated in the enormous rally for other high yield sectors (MLPs & junk bonds) which have had gains of 50%+ YTD. REITs have lagged behind because they have already been bitten very hard by the recession. They collect rents, giving them feedback each month on the vacancy rates for their leases. Each REIT has a different story, but vacancy rates have been rising and are expected to increase further. Dividend increases have been few and limited, dividend cuts were more common (especially in 2009). A major commercial property REIT went bankrupt this year after being near death's door for a number of months. Other marginal REITs have stocks selling in single digits but have been able to remain alive and continue paying dividends (at reduced levels).

To prepare for difficult times, REITs in 2008 sold marginal assets, extended loans and reduced expenses in anticipation of their worst period for many decades. Those owning apartments were able to work with Fannie Mae and Freddie Mac to extend and refinance loans for housing. Real estate is a long term investment. The classical rule was that in a decade there may be two good years, two bad years and the rest are middle kind of years. That scenario was playing out in the current decade, the first 7 years were middle and good for REITs. However this time the bad period may last for 4 or 5 years. The middle and good years will come after that. REIT investors have to be brave while they wait for vacancy rates to stabilize and then recede. They will, eventually. The faithful should be rewarded going forward but they will need patience.

Disclosure: no positions