Are REITs Ready to Break Through to 18-Month Highs?

Includes: IYR, SPG, WPG
by: Avi Morris

Stock markets are in rally mode and the higher yielders are getting a lot of attention as they did last year. The Alerian MLP Index is still close to the 300 ceiling which has held twice. Junk bond funds are at or near roughly 18 month highs (bringing more modest yields). REITs over the last 6 months have been stumbling while trying to make new highs. The Dow Jones REIT Index had been near 330 three years ago and then held well in the first 8 months of 2008. But in September it fell one third to the 180-190 area, which has served as ceiling since then. The Dow Jones REIT Index hit a 181 high in September 2009, then slipped back. In December it reached 190 only to pull back again. Since February, the index has been in a rally mode and only needs another 3 points for another post Lehman collapse peak.

While REITs benefited from higher stock prices they also received a significant boost when Simon Property (NYSE:SPG) made a bid last month for General Growth Properties, the only REIT forced to file for Chapter 11 in this recession. The offer was rejected with the hopes of even greater rewards after emerging from bankruptcy. The optimism about General Growth Properties was based on recognition that strong underlying values remain in owning real estate. An old rule of thumb for real estate said that in a decade there are 2 very good years, 2 bad years and the rest are middle years. This time the bad period is worse, longer and deeper than any since the depression. And all indications are that the bad period will not end soon.

A good story about long term values involves Glimcher Realty (GRT). I bought it for my IRA about 12 years ago. They have a lot of debt financing real estate, mostly commercial properties. The dividend was slashed and the stock was on death's door last year when markets were at their lows. Since then it has rebounded to $4.50 and has been allowed to keep paying a modest dividend. While it remains shaky, not a recommended investment for most, my investment just broke into the black thanks to shares purchased with reinvested dividends which have covered the decline in market price. For comparison, my other REITs are up sharply from higher stock prices and shares which have doubled from reinvested dividends.

Higher vacancy rates and rent concessions on lease renewals are the root problems for REITs, but they have persevered. Expenses have been squeezed for over 2 years and borrowings have been extended or refinanced. Low interest rates on mortgages are helping REITs keep the critical interest expense lower than it would have been otherwise. Banks hold many loans and they are working with REITs to keep them alive.

Going forward the question becomes how well REITs can hold up in a challenging environment. A strong and speedy economic recovery will solve many problems (as will be the case for companies which have issued junk bonds). A faltering or slow recovery can lead to failures. If the REIT index breaks through its 190 ceiling and holds, REIT stocks could have another major leg up on their road to recovery. But fundamental problems of higher vacancy rates and extending leases with limited increases or even at lower terms will remain for some time.

Disclosure: Long SPG, GRT