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Wall Street finds safe harbor in REITs

By Debra Hazel and Dave Bodamer

Finally, REITs may be getting what they deserve: higher share prices a bit more commensurate with their value.

The recent interest rate increases by the Federal Reserve Board that are slowing the overall stock market may be boosting the appeal of real estate investment trusts. But what that means over the long term is still cloudy.

The National Association of Real Estate Investment Trusts’ Equity REIT Index showed year-to-date returns of 10.35% through May 31. That contrasts with a 1.17% loss for the year ended April 30, 2000. Moreover, REIT stock prices in early June were at their highest levels since last September, according to data provided by Salomon Smith Barney, New York City.

“We’re seeing more interest from the small- to mid-cap investor. This is a flight to old-line investments,” said Perry Grueber, vice president/director of investor relations for Developers Diversified Realty Corp., Cleveland, a neighborhood center REIT.

It also is a major change from Wall Street’s thinking of just a few months ago.

“Investors are looking to balance their portfolios again and get back to fundamentals,” said M. Larry Myrvold, senior vice president of the retail group at Duke-Weeks Realty, Indianapolis. Burned by the rapid plunge of some high-tech issues, mutual fund managers are looking for a more stable investment and may be turning, at least in part, to REITs.

The Morgan Stanley REIT Index was up about 10% for the year on May 25. Meanwhile, the Dow Jones Industrial Average was down 10.2% and the Nasdaq down 21.2%. In terms of specific sectors, strip center REITs were up 9.7% for the year with a dividend yield of more than 9%. Regional malls were up 14% with a yield of 8%, and outlet centers were up 8.6% with a yield of 9.6%.

“The investment community is no longer as infatuated with Internet activity as it was,” said Charles B. Lebovitz, chairman of CBL & Associates Properties, Chattanooga, Tenn. “There’s a return to equilibrium as they look for solid results and appreciation potential.”

With the market expected to remain relatively flat for the foreseeable future, investors are becoming more cautious.

“REITs’ staying power and core defensible value is becoming more apparent to a wider audience,” said John J. Kriz, managing director of real estate finance for Moody’s Investors Service, New York City. “Total returns are somewhere between straight bonds and other corporate equity investments. It’s about what you’d expect.”

But the REIT upturn isn’t necessarily a direct flight of capital from other sectors back into real estate.

“Hypothetically, if the outflows from tech issues are X dollars, I don’t think you’d see the same inflow to REIT mutual funds,” said John Bucksbaum, CEO of General Growth Properties, Chicago, at the end of May. “But at least for the last four weeks in a row, we have seen positive inflows of funds to REIT funds, and in 1999, there weren’t that many weeks like that.” As of the end of May, GGP’s own stock had risen about 13% year-to-date.

The flows into REIT coffers also have not been consistent across the board. REITs with high debt leverage are not performing as strongly as other REITs.

Because of recent market conditions, most REITs have tried to sell assets in order to generate cash and increase liquidity. The problem is that not many REITs are in a buying position.

Kimco Realty Group, New Hyde Park, N.Y., long an analyst favorite and industry leader, has seen its stock rise more than 20% this year. While other REITs are selling, it is buying. “We’ve always had a consistent capital structure. Other REITs have too high debt-leverage,” said Scott Onufrey, Kimco director of investor relations. “Our debt is just 33% of our market capitalization. We can add debt. We’re not in a position where we need to sell assets or buy back stock.”

For many companies, buying back stock or issuing additional equity are not attractive options. Most shopping center REITs have been, and continue to be, trading well below net asset value (NAV). Not surprisingly, most developers question NAV as a barometer of success, preferring to add in dividends paid for a total yield.

“We’re not big believers in NAV because it fluctuates,” Bucksbaum said. “This little bump has helped, but we are trading between 10% and 20% below net asset value.”

CBL’s net asset value, according to analysts, exceeds $30 per share, yet the firm closed at 24 7/8 on May 30, Lebovitz observed.

“That’s a significant discount to value,” Lebovitz said. However, as of that date, the stock had risen 20% year-to-date. Even more important, CBL’s dividend is at an annualized rate of 8.2%, giving a total yield of around 25%, he said.

“A big light should go on when a REIT is trading below NAV,” RREEF Securities Principal Karen Knudsen said at NAREIT’s Institutional Investor Forum in New York City last month. “It’s not absolutely important, but it should factor into the strategy of a company.”

Duke-Weeks, trading between $21 and $22 per share in late May, has seen a nearly 40% increase in stock price since early April, Myrvold reported. The Indianapolis-based firm owns and manages industrial and office properties as well as shopping centers. While recent deals for a warehouse and bank may have helped boost the stock somewhat, Myrvold said he believes that the real estate sector itself is gaining investor confidence.

“Our P/E ratio is 15.2, which is very conservative compared with AOL, which is 170 or so. Our dividend yield is 7.4%,” he added.

Grueber, too, noted a rebound in stock price, with DDR shares up close to 30% from the first of the year.

“We’re one of the few companies trading above our IPO price,” he said.

One reason companies can relax a bit about stock prices is the availability of private funding for new ventures. As a result, they have not had to issue new stock at a discount.

“We have no plans to access equity,” said Simon Property Group President Richard S. Sokolov, noting that his company will have $300 million in cash flow after dividends, more than enough to fund its plans.

And a closer look at the industry overall may paint a more subdued picture. Not all stocks have seen a boost: Konover Property Trust has remained flat, largely due to concerns about its outlet center portfolio, though sales are strong, said C. Cammack Morton, president.

“Take a look at the multiples; they haven’t changed much. Marginally, they are still 50% to 60% of what they were two years ago,” he said.

The main problem, according to Morton, is uncertainty over future rate increases by the Fed.

“No one knows when [Federal Reserve board chairman] Alan Greenspan will cut off the spigot,” Morton said. If the Fed were to hold at current rates, REITs might get closer to trading at NAV, according to some experts.

However, most analysts agree that Greenspan will hike interest rates another half-point by late summer or early autumn, before holding them for the rest of the year. Interest rates are rarely adjusted during the final months of an election year.

The most recent increases, in fact, may be painting a falsely rosy picture.

“When you hear about discounts of 10% to 30%, rather than the 10% to 40% of not long ago, my guess is that the cap rate hasn’t been altered for the current interest rate environment. I think interest rates will haunt us for a while,” Morton said.

Where this will lead is still anyone’s guess. De-REITing is not an option for most public companies, according to Morton.

“This means the company would become a taxable entity: Net income would be taxed. Some portion would go to the government, and the rest would be paid out as a dividend. Essentially, there’s not a lot of cash left at the end of the day. And the only reason to de-REIT is to hold on to your cash to reinvest it,” he explained.

Going private or merging with another company is much more likely, though taking a firm private at price close to trading price would be difficult, he said. However, in recent months some REITs have taken such steps. Bradley Real Estate signed a merger agreement with Heritage Property Investment Trust, a private company. Philips International Realty is in the process of de-REITing by selling all of its assets to private investment groups or to Kimco Income REIT, a private-partnership in which Kimco Realty is a stakeholder. Prime Retail Group, which was one of the industry leaders in the factory outlet segment, has had a string of high-profile flameouts that included a $16.5 million loss on its failed e-commerce venture. But other REITs are not concerned about those developments, suggesting that losing weaker players will make retail REITs stronger as a group.

The major financing institutions, meanwhile, are increasing their commitment to real estate: In late May, General Growth, Developers Diversified and Regency Realty all announced significant private placements. Acquisitions could be funded that way.

Expect more consolidation activity in 2001, Morton said, as the effects of the interest rate increases take hold.

“As we get into 2001, we will see a lot of decreasing estimates in FFO growth,” Morton said. “And don’t forget, the total returns for the last 12 months are still down almost 7% for strip centers.”

Still, after years of suffering by comparison with high-tech issues, any boost is welcome.

“As dollars go back in the REIT direction, [investors will] see that a lot of them are pretty good companies,” Duke-Weeks’ Myrvold said. “People are still renting spaces: They need places for retail stores, offices, to store things. Real estate is still a key part of business.”

Wall Street’s greater understanding of REITs also should allow individual companies to be more properly valued, Lebovitz said.

“So often, the REITs have traded in tandem, as a sector, rather than as individual companies,” Lebovitz said. Eventually, each company will be evaluated on its own merits, and “the cream will rise to the top.”