Burp in REITs May Be Just a Case of Indigestion
Wall Street threw a party in the first quarter, but real estate-related stocks were no-shows.
The average mutual fund that owns real estate stocks lost 2.4% of its value in the quarter, according to fund tracker Lipper Analytical Services. In contrast, the average general stock fund jumped 7.2% and the typical bond fund gained about 4%, as interest rates declined.
Real estate mutual funds usually invest in real estate investment trusts, or REITs, which are shares of ownership in pools of property--apartments, shopping centers, office buildings, etc. The REITs typically pass almost all of their rent income and other earnings through to stockholders, who thus share directly in the success or failure of the property pool.
The REIT concept was red-hot in 1993 and ‘94, as Wall Street sold diversification-minded individual and institutional investors on the idea that the U.S. real estate market had bottomed after the crash of the late 1980s and early ‘90s.
What’s more, REIT shares’ specific attributes--high dividend yields, potentially consistent growth of dividends (as rents rise) and immediate liquidity--played well with investors in both ’93 and ’94.
*
So what’s wrong this year? Some REIT analysts and portfolio managers say the problem is largely one of indigestion. The total amount of equity and debt capital issued by REITs rocketed from $6.5 billion in 1992 to $18.3 billion in 1993 and $14.5 billion in 1994, according to the National Assn. of Real Estate Investment Trusts.
The number of publicly traded REIT shares, 138 in 1991, has soared to 224 now.
Given the rise in interest rates over the past year (the recent bond rally notwithstanding) real estate analysts believe that some REIT investors may still be in pruning mode, fearful of higher rates’ long-term effects on real estate values. “I think some people are rethinking what they bought,” says Jeff Everett, a portfolio manager at the Templeton Real Estate mutual fund.
Potential new REIT buyers also may be worried that the real estate cycle is already turning, says Lawrence Raiman, analyst at Donaldson, Lufkin & Jenrette Securities in New York.
While apartments are in short supply in many regions, investors may be assuming that new construction will ramp up soon, Raiman says. Meanwhile, retail space is still in oversupply, he says. If the economy is truly slowing, additional absorption of space could grind to a halt, he notes.
“Over half of all REITs are concentrated in those two sectors of the real estate market,” Raiman says.
Still, REIT bulls argue that many of the stocks are unfairly depressed. With the average REIT’s annualized dividend yield now about 8%, and with many of the stocks selling for low prices relative to the underlying (and generally increasing) value of their properties, REITs’ total-return potential is alluring, some pros say.
“We think there’s a lot of value sitting out there in REITs,” says Dean Sotter, portfolio manager of the PRA Real Estate fund in Chicago.
One clue that REITs are good buys: The 8% average dividend yield is 1.3 percentage points over the yield on two-year U.S. Treasury notes, the benchmark bond with which REITs are normally compared. REITs’ yields also are higher than yields on many electric utility stocks--and REIT dividends arguably have better growth prospects than dividends of most utilities.
How best to play REITs? Investors who want a diversified mutual fund have about 15 to choose from. The two largest: Fidelity Real Estate in Boston and Cohen & Steers Realty in New York.
If you want to buy individual REITs, analysts advise sticking with those that have proven track records and strong finances. New Plan Realty ($20.875, NYSE) is often mentioned.
The Franklin Real Estate fund in San Mateo, Calif., is focused heavily on apartment, warehouse and hotel REITs that can reasonably expect to raise rents 5% to 7% a year, says analyst Tom Branch. Some of the fund’s holdings include apartment REIT Merry Land & Investment ($19.375, NYSE) and FelCor Hotel Suites ($24.125, Nasdaq).
The Templeton fund, meanwhile, holds only 20% of its assets in REITs. The rest is in shares of builders, raw-land companies and other real estate plays. One of Everett’s favorites: developer Rouse Co. ($19.50, Nasdaq), which he calls “cheaper than any REIT” based on the value of its assets.
Raiman’s current favorites include suburban-office REIT Cali Realty ($16.75, NYSE) and Storage Equities ($16.875, NYSE), the well-known mini-warehouse REIT.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Playing Possum?
Mutual funds that buy REITs and other real estate-related securities mostly lost ground in the first quarter despite the general rally in stocks and bonds.
Total investment return Fund 1993 1994 1995* CGM Trust: Realty NA NA +0.7% Franklin Real Estate NA +9.6% -0.7% United Svcs. Real Est. +0.2% -11.6% -0.8% Cohen & Steers Realty +18.8% +8.3% -2.4% Fidelity Real Estate +12.5% +2.0% -2.5% Templeton Real Estate +33.0% -7.7% -2.7% PRA Real Estate +20.0% +3.0% -4.5% General stock fund avg. +12.5% -1.7% +7.2%
NA -- not available (fund didn’t exist)
* first quarter
Source: Lipper Analytical Services
