REITs Posting Negative Returns So Far This Year
Returns from real estate investment trusts have cooled considerably this year, fueling speculation that the highly touted stocks may be more of a conservative investment than most people thought.
Although REIT stocks beat the S&P; 500 five out of seven years from 1990 to 1997, this year REIT stocks as measured by a Morgan Stanley index have posted a return of -3.5% so far, compared with a gain of 6.2% for the broader market.
Even REIT stocks handpicked by professional fund managers have taken a hit. The average REIT mutual fund was down 1.6% through Thursday, while the average general U.S. stock fund was up 5.1%, according to Lipper Analytical Services.
REIT analyst Ralph Block of San Francisco-based Bay Isle Financial Corp. attributes the drop to REITs returning to the trough to raise money in secondary offerings, concern over President Clinton’s proposed REIT legislation and falling property return rates as real estate bargains diminish and REITs pay higher prices for property.
“Investors are essentially telling REITs [to] slow down and make sure what you are buying makes sense,” Block said.
Wall Street analysts have echoed this sentiment. At least one recently downgraded his position on the industry as a whole, from “outperform” to “average performer.”
The general revival in the stock market overall also has dampened enthusiasm for REITs. In the words of an analyst at PaineWebber, “Who wants a miserly return of 12% to 15% when you can get a minimum of 20% in the [broader] stock market?”
Carl Tash, a REIT contrarian and president of Los Angeles investment firm Cliffwood Partners, expects REIT earnings to get squeezed as competition for capital and properties increases.
“I think there’s a good chance that returns could stay mediocre,” Tash said, citing the number of firms readying secondary offerings. This flood of offerings is likely to dampen REIT prices, Tash said, and force more REITs to take on higher levels of debt--in some cases as much as 55% to 60% of their assets.
Still, Block and others expect the REIT industry to average returns of 13% to 15% this year. Solid, but not as stellar as last year’s 19%. The number of choices for investors is likely to narrow too, experts say, as smaller REITs, unable to achieve the economies of scale of larger players, merge.
Firms that will come out on top, at least for the next year, Tash speculated, will be those that are the first to start construction on new properties. Such firms as Washington D.C.-based CarrAmerica Realty and Menlo Park-based Spieker Properties, which are now developing office buildings in robust markets including the Southland, will have an edge. “They’ll come out with 10% to 12% returns, versus someone buying who will get a cap rate of 7% or 8%,” Tash said.
But even if short-term REIT performance looks a little anemic, most analysts don’t think REITs are poised for any big plunge. Indeed, Block said he thinks REITs, which have an average dividend yield of close to 6%, are a good way for investors to diversify a high-growth stock portfolio.
“Real estate is a fairly stodgy asset. It’s less risky than most operating businesses, although there’s not as much upside.”
The most sensible plays for investors, Block said, are REITs where management is invested heavily in the stock. “They are going to be thinking about their own stock position,” he said. “And they are going to be more careful to make deals that don’t come back to haunt them.”
