REIT Stocks May Offer Decent, if Lower, Returns This Year
Fans of real estate investment trust stocks are betting that REITs will retain their luster now that the dot-com delirium seems to have abated.
REITs rallied in the last half of 2000 after an up-and-down first half. Believers are betting that investors will stay in REITs in 2001 because REIT stocks often behave more like bonds and as such can be a relatively safe, if unexciting, investment.
The SNL Equity REIT Index returned 26% last year, contrasted with a 5.4% decline in 1999, said Keith Pomroy, analyst with SNL Securities in Charlottsville, Va.
REITs toiled in obscurity in 1999 and early 2000 as investors ignored the consistent earnings growth and steady dividend returns of the companies in favor of less predictable technology companies that promised higher returns.
The consensus now is that REITs are back in their niche as a “defensive” investment for investors looking for dependable returns. They are not, however, the highflying growth stocks that some investors believed them to be in the mid-1990s.
REIT shares “behave like a bond,” said analyst Craig Silvers of Sutro & Co. in Los Angeles, who forecasts that REIT stocks will return about 16% or 17% this year, counting dividend growth and stock-price appreciation. Although that would be down from last year’s 26%, he said, it would still be an above-average performance for REITs and perhaps better than the stock market as a whole.
But there is concern among analysts that some REIT companies may take a few hits from troubled dot-com tenants.
At Kilroy Realty’s Westside Media Center in Los Angeles, tenant EToys said recently that it is laying off 700 of its 1,000 workers, prompting questions about how much Kilroy might be hurt if EToys unravels further or goes out of business. EToys leases all 151,000 square feet of Kilroy’s building on Olympic Boulevard near Bundy Drive.
But the El Segundo-based REIT is protected against an EToys failure by a $15-million letter of credit from the tenant, Silvers said. He said Kilroy has relatively little exposure to losses from dot-com companies because dot-coms represent a small portion of its tenant base. And, like many landlords, Kilroy has exacted financial guarantees from dot-coms to protect against losing rent through Internet failures.
Nonetheless, concern over dot-coms remains among analysts. On Jan. 5, Morgan Stanley Dean Witter & Co. changed its rating on Menlo Park, Calif.-based Spieker Properties Inc. to “outperform” from “strong buy,” although the move didn’t seem to hurt Spieker’s share price, which moved up 81 cents that day.
Spieker still expects rental income growth in the months ahead, said John Davenport, the company’s Irvine-based president of Southern California operations.
“We’re telling analysts and investors that we don’t expect rent increases to be as great this year as they were last year,” Davenport said, “but last year was extraordinary.”
Spieker has many tenants with leases at below-market rents, so the company expects to raise rents when those leases come up for renewal. In the third quarter ended Sept. 30, rents increased, on average, 83.4% on the 1.9 million square feet of space renewed or re-leased, according to Spieker’s third-quarter financial report.
In addition, Davenport said, the company has about half a billion dollars’ worth of new office development underway, much of it already leased, that will add to earnings once it’s completed.
Silvers believes Spieker will fare well because it is one of a number of REITs that own properties primarily in regions where buildings lease quickly, and it is hard to build new ones.
“We like Arden Realty because it has a high concentration of office space in West L.A., which is a supply-constrained market,” Silvers said. “We like Kilroy for the same reason. Both of those companies have a relatively small exposure to dot-com companies, and their exposure is mitigated by letters of credit.”
Silvers, who focuses on West Coast REITs, believes the outlook for the companies is positive. He expects the economy here will remain healthy, even in a national slowing, but he cautions that investors looking at REIT stocks should scrutinize each company on its own merits.
Among his suggestions for investors:
* Look for REITs with holdings in tight markets where construction is difficult. “There has not been a glut of supply in this cycle the way there was 10 years ago because the banks have been restrained in their lending,” Silvers said. “When you have growing demand and a limited supply, it creates a good situation for property owners.”
* Look for companies with low debt loads in comparison with their total market capitalization, preferably less than 50%. Among Silvers’ picks is Glendale-based PS Business Parks, which has a debt ratio of only 5% of its market cap.
* Look for REITs with low dividend-payout ratios in relation to FFO, or funds from operations, the yardstick by which REIT performance is generally measured. A low dividend-to-FFO ratio means that the REIT will be able to continue paying its dividend if it falters. Most REITs are paying a dividend of about 4% to 9% of their FFO. If the dividend-to-FFO ratio is 11% or more, Silvers said, “there is a high likelihood that a dividend cut is coming.”
* Consider what types of property a REIT owns and how the properties might be affected by economic changes, said Pomroy of SNL Securities. Some properties depend more on discretionary spending than others. Hotels, for example, might suffer if businesses cut back on their travel budgets or people decide they can’t afford another vacation. Office and apartment REITs have more consistent demand.
If current trends continue, according to Pomroy and Silvers, REITs should be in for another good year overall.
“People are tired of the wild gyrations of the Nasdaq or some of these fledgling technology stocks,” Silvers said. “They want real companies with real earnings and growing dividends.”
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REIT Rebound
Real estate investment trust stocks rallied at the end of 2000 to match highs of 1999. Marketobvservers say REITs may again be regarded by investors as a steady, if undramatic, investment.
538976322 Friday: 119.57
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Source: Bloomberg New
