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WHAT LIES AHEAD FOR RETAIL REITS?

April sure put a damper on REIT stocks. The Morgan Stanley REIT index peaked April 1 and then fell 7.3 percent over the next four days. Since then, it has been sputtering. The pundits offered a variety of reasons for the decline. Some said strong job growth in March had emboldened investors to pour more money into the broader equities market. Others argued that the subsequent sell-off in the Treasuries market suppressed prices and boosted yields, thus undermining REITs’ interest rate advantage over bonds. Still others were skeptical of any direct link at all between interest rate spikes and the sector’s performance. So what did go on? More important, what is to come? SCT asked some industry executives.

Jeffrey D. Furber, chief investment officer, AEW Capital Management, Boston It is a positive thing; REITs have just gone up too fast for too long. I would rather see a couple of minicorrections rather than a large correction later.

Jeffrey D. Furber

Stephen D. Lebovitz

Stephen D. Lebovitz, president, CBL & Associates Properties, Chattanooga, Tenn.
When we look at an acquisition and how we finance it, we’ll typically use long-term financing and a percentage of equity. We have not relied on low short-term rates to make our acquisitions work. As rates go higher, we would expect that cap rates would increase somewhat. A lot of it is driven by demand, [but] the performance of real estate as an asset class has been [a factor] in driving cap rates down as much as low interest rates. We’re seeing the best sales in our portfolio that we’ve seen in the past five years. We’ll continue to see demand from retailers to lease space, so from an investor point of view, it is a solid investment.

It is hard to watch your stock price decrease, but we’ve had four unbelievable years of growth. A year ago, at the end of the fourth quarter, our stock was at $40.59. Over … the long term, we’re pleased with our return and our prospects going forward. We’re in this for the long term, and we feel we’ll continue to be rewarded for our performance.

Jeff Donnelly

Jeff Donnelly, director, real estate/lodging equity research, Wachovia Securities, Boston
Within the REIT sector, retail REITs sold off disproportionately relative to sectors with shorter lease terms [and that] are believed to have more sensitivity to an improving economy. I continue to believe that the retail group remains attractively valued, particularly given its markedly higher and more-visible earnings growth and attractive, safe dividend yields. All this sell-off did was effectively bring valuations back to where they were at year-end 2003. [That] seems reasonable, considering the 10 to 15 percent rise they experienced in the first quarter of 2004.

Gary Mozer

Gary Mozer, CEO, George Smith Partners, Los Angeles
Real estate in general is interest-rate sensitive, because a majority of buyers use debt. Institutional buyers use low leverage, while the largest part of the investment community uses high leverage. The real estate industry has turned to this low cost of debt, which made properties easier to buy. Now all of a sudden you have this huge increase in Treasuries and a huge run-up in values. The real estate market does not like change, and no one likes uncertainty, so when we have a big change in the 10-year Treasury — from 3.7 percent to 4.45 percent since the end of March — you have a shock to the system.

Buyers are paying a lot for the properties they are buying now; they need this leverage to get their yields. When a cash-on-cash yield for a leveraged buyer has gone down, the property values will go down. Demand for real estate assets still outstrips supply, but the prices will change.

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