Investors Turn Pessimistic,
Yet Strong Fundamentals
Provide Some Protection
By KEMBA J. DUNHAM
December 26, 2007; Page B4
While signs of an economic slowdown and turbulent capital markets are scaring investors away from real-estate investment trusts, analysts say many REITs are prepared to weather the tough 2008 that many economists predict.
REITs are publicly traded companies that pay out at least 90% of their income in dividends. After several years of outperforming the Standard & Poor's 500-stock index, REIT stocks have had a miserable 2007: Total returns have declined 21.9% from their peak in February, according to SNL Financial's U.S. REIT Equity Index.
Investors, particularly those not dedicated to REITs, have been spooked by the gloom-and-doom headlines about the slowing economy, subprime-mortgage crisis and carnage in the capital markets. Many are convinced that REITs' growth prospects have weakened, especially since property values in many asset classes have begun to decline.
"Certainly, there's absolutely no rush to get back into the sector, especially from non-REIT dedicated investors," BMO Capital Markets analyst Paul Adornato said. "Also, [regarding] the dedicated investors who might have cash on the sidelines, I don't sense that there's any urgency to buy even good-quality names at this point."
Still, fundamentals within property sectors have remained solid. Vacancy rates are low, and rents in retail, office and industrial properties are still high. Most sectors also haven't suffered from the kind of overbuilding that pulverized commercial property in the early 1990s.
Moreover, most REITs are insulated from the capital crunch bedeviling many private real-estate owners. REITs typically have low leverage and have developed different ways to raise cash during downturns.
"Our analysis suggests that REITs overall are relatively well-positioned to endure a capital-constrained environment in 2008, in contrast to recent market sentiment and despite a few company-specific headlines of late," Ross Smotrich, an analyst at Bear Stearns & Co., recently said in a research note.
BMO's Mr. Adornato pointed out that in recent years, REITs have become skilled at forming joint ventures with institutional partners, which bring in hefty fees. Also, most have access to revolving credit from banks when other sources of capital are scarce, Mr. Adornato said.
Ray Braun, president of Health Care REIT Inc., based in Toledo, Ohio, said his company renegotiated its line of credit this summer and now has $1.15 billion in borrowing capacity. The company also completed an equity offering in December and a convertible-debt offering in July. That puts Health Care in a position to buy when private investors are having difficulty raising capital, he says.
"We...expect to continue to make accretive investments next year across the full spectrum of health-care real estate," Mr. Braun said.
Hamid Moghadam, co-founder and chief executive of AMB PropertyCorp., an industrial REIT based in San Francisco, said his company is also well-positioned because of strong demand for industrial space and very little overbuilding. "I think a pretty signature part of our business is development, and there are lots of opportunities for development around the world," he said.
The future will look brighter for some REIT property sectors than others, analysts say. Industrial REITs may benefit from global trade, while the health-care REITs might find continued opportunities from the growing number of aging Americans, analysts say. Apartment REITs may benefit from the housing market slowdown as would-be buyers decide to rent instead.
Retail may take a hit if consumer spending slows, while office companies, particularly those focused on major financial centers, might be hurt if companies take less space or hold off their leasing decisions.
Still, James Kammert, portfolio manager at Transwestern Investment Co., an asset manager based in Chicago, said it is a "coin toss" in picking sectors going into 2008, given the daily and month-to-month volatility across sectors this year.
"I think investors will be far better served owning the superior business models across REIT land -- such as SL Green Realty Corp. -- and avoid making macro calls on sectors when there is so much noise and jittery funds flow," he said.
Mr. Kammert said he doesn't expect major mergers-and-acquisitions activity in 2008. "I expect a muted M&A environment. Why buy a whole company when much of the obvious public-to-public matches have been done already?" he said.
Write to Kemba J. Dunham at kemba.dunham@wsj.com
