REITs Recovering Former Luster as Investments
Real estate investment trusts, darlings of the investment world in 1996 and 1997 before they fell from favor and their stock prices tumbled last year, are making their way back into the good graces of many analysts and investors.
But just as REITs revive, the Federal Reserve is hinting that it might raise interest rates later this year, prompting analysts to wonder if the month-old REIT rally will last.
Interest rates raise concern because today’s REITs behave more like bonds or utilities than the highflying growth stocks they were promoted as a couple of years ago, analysts say. If interest rates jump, bonds might offer significantly higher returns than REITs, so investors might switch some funds out of REITs and into bonds.
“REITs have a bond-like quality to them, in terms of valuation, so if interest rates would spike and bond values drop, some of that would spill into the REIT sector,” said Jim Sullivan, an analyst with Green Street Advisors in Newport Beach.
Nonetheless, Sullivan views today’s relatively low prices of publicly held REIT stocks as something of a puzzlement.
“The average REIT in the universe of 75 companies that we track is trading at about an 11% discount to net asset value,” Sullivan said. “When you look at the real estate markets and most property types in most parts of the country, it’s hard to understand why the average company would be trading at a discount.”
“You can think of REITs as growth utilities without the government regulation,” said Craig Silvers, an analyst with Sutro & Co. in Los Angeles.
Silvers said Sutro views REIT stocks as “very attractively” valued, based on their dividend yields as well as their price-to-earnings multiples. REITs generally are paying higher dividends than the broader stock market, Silvers explained, while their lower price-to-earnings multiples suggest potential for their stock prices to rise.
“There’s a big disparity between Wall Street and Main Street,” Silvers said. “If some of the REITs went private, their stock would probably fetch 20% more than [they are] valued in the public markets. We think most REITs are from 5% to 20% below their private market value.”
Today’s take on REITs is that they were only temporarily suited for their role as growth stocks. They enjoyed a brief window of opportunity to buy properties at low prices right after the recession, reaping quick, steep profits when those properties rose in value. With property prices much higher today, REITs have to work harder for profits and must demonstrate that they can manage properties profitably.
REITs started returning to favor last month, in part because of investor Warren Buffett’s disclosure that he bought about $50 million worth of REIT stocks, Silvers said. But he believes they were due for a slow resurgence even without Buffett’s boost.
“People are looking at REITs as a good, safe investment,” said Victor Coleman, president and chief operating officer of Brentwood-based Arden Realty Inc., which owns and manages 18 million square feet of office buildings in Southern California. Arden, one of the most active buyers during the REIT acquisition spree in the mid-1990s, is Southern California’s biggest office landlord.
“In real estate, unless you’re buying assets, which is the glory part of the business, you’re not on the front page,” Coleman said.
But REITs in general and Arden in particular have remained very active despite their slower pace of acquisitions and lower media profile, Coleman said. Arden has continued its acquisitions, albeit on a smaller scale, and is developing a number of new or rehabilitated properties.
Among its premier projects are the new Howard Hughes Center, a 70-acre development along the San Diego Freeway just east of Sepulveda Boulevard, and the renovation of Westwood Center, a 313,000-square-foot office building in the heart of Westwood.
At Howard Hughes Center, the company began construction late last year on a 240,000-square-foot speculative office building scheduled to be completed early next year. It is the first phase of a project that is slated ultimately to include 2.5 million square feet of office, industrial, retail, entertainment and hotel space.
At Westwood Center, Arden is completely renovating a building that suffered from a 60% vacancy rate, “undistinguished architecture, dated systems and a poor overall image,” according to the company’s annual report. The building is targeted for completion at the end of this year.
Arden, which has 4,000 tenants in its 18 million square feet of space, completed 905 lease transactions on 4.2 million square feet of space last year, Coleman added, noting that the company is getting higher rents in virtually every new or renewed lease.
Like Coleman, Chief Executive Kenneth B. Roath of Newport Beach-based Health Care Property Investors Inc. pointed out that REITs haven’t exactly been standing still.
Health Care Property Investors bought $458 million worth of new property in 1998, surpassing its previous record of $262 million in 1997. The company is buying at a slower pace this year, having spent about $130 million on acquisitions to date, but Roath said acquisitions this year could equal last year’s total if the company finds properties that it considers good deals.
Roath said institutional investors played a big role in vaulting REIT stocks into the growth-stock stratosphere and also helped bring them down.
“The industry attracted a lot of growth-oriented institutional investors who have now moved out of the REIT sector,” Roath said. “We had two big institutional investors that switched out during the year, which hurt our stock.” He said the company has since picked up some institutional support and has fared well with individual investors, but its stock is still trading well below its previous high.
Health Care Property Investors, Roath noted, is one of the few REITs to have issued new stock lately. The company issued 1 million shares at $30 per share in an offering completed the first week in May. Its stock Monday was down 44 cents, closing at $30.31 on the New York Stock Exchange.
Roath said Health Care Property Investors’ results illustrate the gap that sometimes separates a company’s financial performance and its stock price.
“Here we are, a company that has paid 54 consecutive quarterly dividend increases, and 1998 was our 14th record consecutive year of growth in FFO [funds from operations, a measurement of an REIT’s financial performance], but the stock price is not reflecting that,” Roath said.
REITs are refining their operations, said Doug McEachern, a real estate consultant with Deloitte & Touche.
“They’re reviewing portfolios, trying to determine which properties they have that are not strategic that they might want to dispose of, and they’re adding value by rehabbing properties. They’re also still making acquisitions, just on a smaller scale,” McEachern said. “A number of them are buying back their stock because they believe it to be undervalued.”
The question about REIT stocks, according to McEachern, “always was whether they were going to be growth stocks or more conservative investments.”
Today, he said, “they appear to be very good investments, but not the rapid-growth stocks that people once might have thought.”
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Revival for REITs
Real estate investment trusts are making their way back into the good graces of many analysts and investors. But as property prices rise, REITs have to work harder for profits and must demonstrate that they can manage properties profitably. The Morgan Stanley Real Estate Investment Trust Index, weekly since May 1, 1998:
Monday: 324.43
Source: Bloomberg News
