Health Care and Economy and Real Estate & Retail

Right time for REITs?: Some predict beaten-down sector is ready for another winning streak

February 25, 2008

For seven years, real estate investment trusts delivered returns that clobbered the overall stock market.

Then, last year, the winning streak came to an end. Between January 2007 and January 2008, REITs as a whole lost 24 percent of their value. An index of the companies took a bigger hit than most every other sector.

Among local REITs, Duke Realty Corp. was the hardest hit, with its stock price falling 44 percent, from about $41 to $23, during the one-year period. Simon Property Group Inc. dropped 20 percent, from $110 to $88. Kite Realty Group sunk 28 percent, from about $18 to $13.

Now, many investors are wondering whether the time for REITs is right again. Analysts who follow the companies are seeing new buying interest thanks to more attractive valuations.

In fact, one of the most prominent analysts covering real estate investment trusts-Jonathan Litt of Citigroup-has resigned his position to focus on investing in REITs.

"The current credit crisis is laying the groundwork for a great buying opportunity in real estate," Litt wrote in a farewell message to friends and colleagues.

Institutional investors that stayed away during the booming years have been giving REITs a look again, too, said Brad Case, vice president of research and industry informa- tion for the National Association of Real Estate Investment Trusts, or NAREIT.

"They're certainly going to turn up at some point," Case said. "I don't know when. But I think it's possible we're at or near the bottom of the market."

Tightening credit markets are affecting real estate investment trusts, but not to the same extent as residential players. That's because most commercial REITs have limited debt leverage ranging from 45 percent to 50 percent, said Ralph Block, author of the book "Investing in REITs" and a retired portfolio manager.

For the most part, the REITs also have stable cash flows thanks to long-term leases. And there isn't an excess supply, unlike previous real estate cycles.

"The real issue for REIT investors is what the credit issue is doing to the U.S. economy," said Block, who lives in California. "It's certainly slowing the demand for new retail space. And companies have become more conservative on office space."

Block expects the economy will continue to sour, but he believes REITs will stabilize by 2009.

A popular investment

Real estate investment trusts were reestablished in the 1960s to give individuals an easy way to invest in income-producing real estate. The companies, which typically focus on distinct areas of real estate such as office, retail or apartments, must pay shareholders at least 90 percent of their taxable income each year. Investors can own shares in individual companies, REIT mutual funds or REIT exchange traded funds.

It's a popular way to invest in real estate. Since 1971, the number of REITs has grown from 34 to more than 150, and market value shot from about $1.5 billion to $312 billion, NAREIT data shows.

Many financial advisers consider real estate one of four fundamental asset classes-along with stocks, bonds and cash instruments. For individual investors looking for well-diversified exposure to real estate, exchange traded funds have become a popular option. Choices include the Dow Jones Wilshire REIT ETF (RWR) or the Vanguard REIT Index (VNQ).

For investors looking to own individual REITs, Block recommends avoiding office- and industrial-focused companies for now. He said office rents have gone down after previous recessions. But he does like three sectors: health care, apartment communities and shopping malls.

In the health care sphere, his picks are Newport Beach, Calif.-based Nationwide Health Properties (NHP) and Louisvillebased Ventas (VTR). His top pick for apartments is Virginia-based Avalonbay (AVB). For shopping centers, he likes locally based Simon (SPG) and New Yorkbased Kimco Realty Corp. (KIM).

Finding a bottom

Historically, real estate investment trusts have undergone three major downturns, each lasting 14 to 27 months. REIT indexes fell 37 percent from September 1972 to December 1974, 24 percent from August 1998 to October 1990, and 24 percent from December 1997 to November 1999.

The 24-percent drop from January 2007 to January 2008 aligns closely with the previous two dips, suggesting the market could have found its bottom, Case said.

He also is encouraged by valuations. REIT share prices typically average 4 percent more than the value of the properties held. In the current situation, Case said, REIT stock prices are trading at about a 20-percent discount to the value of the assets.

In the past, publicly traded REITs have fallen well before the real pain begins for commercial real estate. Case said the carnage has "hardly started" and commercial property values are likely to fall. By then, REIT prices could be heading the other direction.

Of course, not everyone is bullish on REITs. In a January MarketWatch column, Chuck Jaffe called Simon Property Group his "stupid investment of the week." He said the shares still are overvalued and have much farther to fall.

The biggest challenge for REITs will be "transitioning from denial to acceptance that the debt markets have repriced," said Steven Marks, managing director of Fitch Ratings, in a Q&A with the magazine Real Estate Portfolio.

Still, Marks told the magazine his outlook for REITs is positive, thanks to conservative balance sheets, ample liquidity and access to various sources of capital.
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