REIT Prices Continue to Fall, but Some Call Them Bargains


Real estate stocks have continued to slide in recent weeks, as concern over less-bright growth prospects has prompted individual shareholders to sell and many fund managers to turn a cold shoulder to a category they once embraced warmly.

"Mutual funds are now going back to utilities," said Mike Kirby, principal of Green Street Advisors Inc., a Newport Beach-based research firm specializing in real estate investment trusts. "Investors have cooled to the [REIT] stocks."

Fresh concern over overbuilding, pending legislation affecting REITs and declining margins on acquisitions has pushed REIT prices down even further in recent weeks. Bloomberg's index of 160 REITs is down 1.9% since May 15--6.9% for the year, whereas the blue-chip Standard & Poor's 500-stock index is up 0.6% since May 15--and a whopping 15% year-to-date.

The slow and steady price decline in the REIT market has prompted some analysts to classify them as relative bargains. As Kirby points out, the average S&P; stock is currently trading at about 22 times earnings, whereas the average REIT is trading at about 12 times its funds from operations, a similar performance indicator.

Although a small gap is normal, "It's unprecedented to have that kind of disparity between REITs and the S&P;," Kirby said. "On a relative valuation, REITs are starting to flash the signal that they can't get a lot cheaper."

The stocks that have taken the biggest hit this year are last year's high fliers--in particular, hotel and office building companies, which snapped up bargain properties last year and posted fatter returns, according to analyst Ralph Block, author of "The Essential REIT."

As competition for properties has intensified and internal rates of return slipped, so-called momentum investors have begun selling.

Also dampening REITs' Wall Street performance of late has been the evolution of private "unit trusts," a collection of funds that invest directly in real estate companies, circumventing Wall Street altogether. "Over $3 billion has been raised by these things this year," Kirby said. "That takes $3 billion out of the normal supply-demand pipeline on the floor of the stock exchange."

But if REIT prices look grim now, Block argues that over time, the vehicles will perform on a par with stocks in other industries. He predicts that most will post returns of at least 13% to 14% a year for the long haul, compared with the 11% returns posted historically by stocks in the broader market.

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