REITs Reviving--but Experts Urge Caution
Real estate investment trusts, a financial scourge of the mid-1970s when many collapsed and investors lost billions of dollars, are coming back and multiplying with a vengeance. More new REITs were organized in the first half of 1985 than in the past four years combined.
But the trusts’ booming growth, spurred by high yields in recent years and the threat that tax reform will hurt other real estate investments, could be coming at an inopportune time, some investment experts fear.
REITs--companies that pool shareholders’ money to buy or finance shopping centers, office buildings and other properties and pay 95% of the profits in dividends--are beginning to suffer from a nationwide glut of commercial property, experts say. High vacancy rates are pinching rental income while lower inflation is cutting profits from gains in property values.
Meanwhile, many new REITs are buying high-priced or risky properties, as good, bargain-priced real estate is hard to find, these experts say.
Consequently, many new REITs fell short of raising the investor capital that they wanted and their stocks are trading lower than their initial offering prices. A few established REITs, including two of the largest, have recently announced lower earnings and dividends, depressing their stock prices.
“Investor expectations of income growth from REITs cannot be as high as in the recent past,” says Martin Cohen, portfolio manager of a real estate mutual fund that invests in REITs, offered by National Securities & Research.
“Anytime you bring on a lot of new players in any market, there’s going to be some weak sisters,” says Arthur G. Von Thaden, chairman and president of BankAmerica Realty Services, which advises a REIT offered by the banking firm. “Not all will have strong managers, and not all will produce good results.”
But while dividends and stock prices will be hurt in the short run, the industry overall is in good shape financially and many REITs will remain good investments in the longer term, experts say.
Nobody expects a recurrence of the mid-1970s when some REITs failed and the industry shrunk in half amid a slumping real estate market.
In those days the trusts relied heavily on short-term loans that they used to make mortgage loans for high-risk construction and development projects. When those projects defaulted and interest rates shot up, many REITs could not make loan payments, in turn causing millions of dollars of losses among U.S. banks.
Much Smarter Today
Today’s REITs, by contrast, are much smarter and less reliant on borrowings than their predecessors, experts say.
Most REITs are the safer, equity type that own properties rather than lending to them. Many equity REITs, in fact, survived quite nicely a decade ago when mortgage REITs were suffering.
Accordingly, REITs are considered one of the safest real estate investments today. They also have been among the most attractive financially.
Between 1979 and 1984, REITs posted a compounded annual return of 20.5%, compared to 16.1% for Standard & Poor’s index of 500 stocks, says the National Assn. of Real Estate Investment Trusts (NAREIT).
Such attractive returns, along with anticipation that tax reform will reduce write-offs from real estate tax shelters and favor income-oriented real estate investments such as REITs, have helped spur the surge in new REITs.
At least 16 REITs have completed initial public offerings this year and 28 are in the process of initial offerings, adding to the 125 already in existence. About 28 companies completed $1.5 billion of new REIT offerings this year, more than double the $712 million in new offerings from 23 firms all last year, NAREIT says.
Still Below Peak
REIT assets totaled $11.8 billion as of March 31, $4 billion more than a year earlier although still far below the $20.5-billion peak in 1974, NAREIT says.
Most notable among the flurry of new REITs is one planning to offer partial ownership in Manhattan’s famed Rockefeller Center in a $20-per-share, $600-million offering. The publicity surrounding that deal appears to be spurring other builder-developers to consider forming REITs to sell their properties while retaining management control.
Stan Ross, co-managing partner at Kenneth Leventhal & Co., a Los Angeles-based accounting firm specializing in real estate, says that since the Rockefeller deal was announced, the firm has begun working with builder-developers on two proposed REITs, each with market value exceeding $500 million, far bigger than the $100-million deals generally considered large.
But many experts urge caution in investing in new REITs, particularly “blind-pool” trusts that haven’t yet specified what they will buy, as well as those without proven track records in real estate investing.
New REITs that haven’t yet bought properties are hampered because “real estate prices are high and returns are low,” says Alan Crittenden, a Novato, Calif., real estate newsletter publisher.
Despite the commercial real estate glut, REITs and other institutions, such as insurance companies and real estate syndicates, have been competing for prime real estate, bidding up prices and making it harder to find good deals, he says.
“There’s lots of money coming in, and only so much quality property,” says Mark Decker, executive vice president of NAREIT.
Less Attractive
Such conditions are making real estate less attractive as an overall investment in the near term, says Robert A. Frank, real estate analyst with Alex. Brown & Sons, a Baltimore-based investment firm.
He says real estate will generally produce smaller returns than other assets in the next three years, barring an unusually strong surge in demand for office and residential space.
“Investors in new REITs are being taken for a very unpleasant ride,” portfolio manager Cohen says, noting that 12 of 13 new REITs that he is tracking are selling below their initial offering prices.
Grubb & Ellis Realty Income Trust raised only $25 million in its initial offering in April, instead of the $50 million that it hoped for, and its share price has lagged below its $20 initial offering price.
ICM Property Investors, another recent offering, managed to raise $115 million of an expected $125 million and its share price also has languished below the initial tag.
Analyst Frank contends that pension funds and other institutions are not buying many of the new deals, preferring to wait for share prices to fall further.
The new deals are instead being bought by less-sophisticated retail investors who are not as able to size up REITs’ management expertise, generally said to be the single most important factor in evaluating a REIT.
Strong Track Records
Consequently, many experts are recommending that investors stick for now to established REITs with strong track records.
Often-recommended older REITs include Santa Anita Realty Enterprises, which owns the Santa Anita race track; Federal Realty Investment Trust; Lomas & Nettleton Mortgage Investors, and First Union Real Estate Investments.
But established REITs are not without their own share of problems.
Two of the nation’s largest REITs, Consolidated Capital Special Trust and Consolidated Capital Income Trust, last month announced declines of 92% and 68%, respectively, in second-quarter earnings due to increases in non-earning loans. Their stock prices plunged sharply.
Their decline was a large factor in causing the total industry-wide return for REITs in the 12 months ended Aug. 31 to fall to 16.45% from 30.07% for the 12 months ended July 31, according to NAREIT.
Americana Hotels & Realty, a REIT that invests in Americana Hotels properties, saw its stock price drop about 20% in one day last March after it reported that its earnings would begin to fall in 1986.
Pressures to increase or maintain yields is leading some REITs to invest in riskier deals, such as joint ventures with developers to build new office and residential buildings, portfolio manager Cohen says.
Such deals could produce higher profits if successful, but they also risk lower earnings or even losses should occupancy and rental rates fall below expectations, he says.
If that happens, the whole REIT could suffer, since some trusts have only four or five properties altogether. “If any one of them is a loser, the whole trust is a loser,” Cohen says.
Stocks Bid Up
Also, stocks of established REITs are not cheap, some having been bid up in the recent investor frenzy. REIT stocks now are generally selling for about 90% of the per-share appraised value of their real estate holdings, compared to 70% two years ago, BankAmerica’s Von Thaden says.
And REITs’ rate of return is not expected to match the impressive levels of recent years. “If you’re expecting to get a 22% return over the next couple of years, you’re making a big mistake,” analyst Frank says.
However, today’s real estate glut is likely to turn into a real estate shortage three or four years ahead, experts say. If one is willing to hold trust shares for several years, accountant Ross says, “REITs as an investment could be a very good play.”
