REITs will stage a comeback. And when they do it would be wise to have an appropriate amount of your portfolio devoted to this excellent diversifier in the form of a good REIT fund.
Below is an excerpt from an article by Eric Rasmussen describing how and why the REITs are behaving the way they are. Remember that the article is talking about the REITs themselves as opposed to the funds that hold them.
In the real estate investment trust world, the motto right now is ”Build, baby, build”—not skyscrapers. Not malls. Not green bungalows on Park Place.
No, right now REITs have to build capital. And fast….
It wasn’t supposed to happen this time. Putting aside for a moment the overheated housing market, the bull years of the mid-2000s were not so much characterized by the rampant overbuilding of new malls, hotels, office parks and skyscrapers, say portfolio managers. Because supply was in check, some believe REITs should have been in a better position to weather a downturn.
But then came 2008. Not only were REITs slaughtered like everything else, but they dipped even farther and faster than the S&P by some measures. The SPDR Dow Jones Wilshire REIT ETF fell 42% for the year. Those declines quickly wiped out much of the breathtaking 328% returns the sector experienced from Jan. 1, 2000, to the end of 2006. From that peak in February of 2007, the index had lost 60% of its value by the end of 2008.
As it turns out, the cheap debt that has undone other sectors of the economy has stained the hands of REIT owners as well, and the sector is awash in leverage these companies are now struggling to cover at the same time the economy sours and rents plummet.
A case in point is the stunning crash of General Growth Properties, one of the largest mall owners in the country with more than 200 shopping centers. The company declared bankruptcy in April after its stock price dived by a vertiginous 97% in 2008. The reason for its Chapter 11 filing was not that it lacked cash flows, say portfolio managers, but that it had so laden itself with debt it could no longer refinance it all….
Using the lubrication of easy lending terms to pursue growth, REITs are now going to have to spend time bulldozing the bad stuff off their books—at a time when banks have frozen lending and are not as liable to refinance.
Meanwhile, the bad economy has crimped need for retail space, hotel space, and office space, making for scarcer occupants, pruned rental income and diminishing real estate value.
Thus REITs have been whipsawed, finding themselves having to go out and find more loans when the value of their collateral has fallen. The regular method of rebuilding capital—dumping property—is hard to do when everyone’s got buildings on the block.
Investors might think now would be a good time to go in and find good deals—great buildings unfairly valued in the economic malaise… But the outlook for these companies is so uncertain that his group now says it wouldn’t recommend purchasing a REIT stock unless the discount was 50%. Bankruptcies are likely, says the report….
Another attractive REIT feature that should be tantalizing investors is the rising dividend yield. REITs are particularly juicy income investments, since they are required to pay out 90% of taxable income every year as dividends.
But even that has become a phantom feature, less tantalizing now when downward rent pressure and more desperate capital needs have forced many companies to cut or suspend their payouts. The yields may be at historic highs, but poor cash flow makes a lot of those dividends untenable….
News?
Although he concedes that the industry is going to be smarting for a while, that’s mainly because of what’s happening in the broader economy with the financial and liquidity crisis—and it has less to do with the inherent weakness of the asset class. The fundamentals of the companies themselves are fairly good, he says....
Those [REITs] that are going to be the most successful, he says, are the ones taking a multi-pronged approach to refinance their debt maturities—by selling assets, delaying or reducing capital expenditures or raising new equity. He likes it when these companies bring new issues to market….
Bloomer says that as long as capital remains tight and banks aren’t willing to refinance debt that’s coming due, we’re going to see more stress in the space. “As things are right now the pain is definitely not over,” he says. “If lending does return in a short amount of time, things will improve. But the problem is we’re not overly optimistic that that’s going to happen yet.
”Dividend cuts will probably become more common,” he adds, “and they’re not going to return until that capital picture improves and they know they can rely on the banks to roll over their debt on reasonable terms. And it’s very hard to predict but all indications now are that we’re still at least year or two away from that.”
