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Shopping Centers Today -> October 2003
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WILL ECONOMIC RECOVERY HURT REITs?
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Amid the turmoil elsewhere in the stock market, real estate investment trusts have been a safe haven for investors. But with the economy seemingly improving, some wonder whether their popularity will erode once the market stabilizes.
The major stock market gauges are hinting at an economic recovery and smoother sailing for investors. Since January, the Standard & Poor’s 500 index has risen 13.3 percent, the Nasdaq is up 33 percent, and the Dow Jones industrial average is up about 12 percent, according to Thomson Financial, a New York City-based market data provider.
But REITs have lost no ground to date. The Morgan Stanley REIT index, based on returns starting at a base of 200 on Dec. 31, 1994, crossed the 500 mark for the first time on July 3 and hit a high of 528.44 on Sept. 3. These numbers suggest that REITs continue to attract investment dollars and that the sector is more than just a reactionary investment option for panicked shareholders.
According to Dan Sullivan, managing director of REIT fixed-income research at Wachovia Securities, investors learned a lot about REITs during the tech bust: They offer steady income, they have the best dividends in the equities market, and they have potential for big returns.
“Even though the rest of the market is rallying, people have been comfortable keeping their money in REITs,” Sullivan said.
Things started to rebound in mid-June. Yields on the 10-year Treasury note began rising dramatically, from slightly more than 3 percent at that time to 4.43 percent in late July. Such a spike in interest rates may cause concern among real estate companies. That’s because Treasuries are the most widely used benchmark for setting interest rates for commercial mortgages and corporate financing, and thus a rise in Treasury yields immediately increases the cost of borrowing.
The Treasury yield increase was due mainly to improved investor attitudes, thanks to signs of an overall economic recovery, says Sullivan.
The Treasury spike did not rattle most REITs, however. This is in keeping with the real estate industry’s pattern in recent years of taking a conservative and strategic approach to interest rate fluctuations and of not responding rashly.
“We do not try to, on a short-term basis, catch rates at critical points,” said William Cornely, treasurer and COO of Glimcher Realty Trust, Columbus, Ohio.
But though some say that REITs have little vulnerability, one market player sees the recent run-up as a wake-up call. Interest rates, especially those at 5.25 percent on 25-to-30-year amortization loans, have been artificially low, insists Michael Pollack, president of Pollack Real Estate Investments, Mesa, Ariz.
Borrowers who tended to make deals because the financing was cheap may pause now that interest rates have increased so dramatically. Further, the cap rates that were driven down by relentless investors are still, in Pollack’s opinion, artificially low.
If those rates stay low amid rising interest rates, they can set up a potentially money-losing scenario for anyone who paid dearly for a property and focused on cheap financing to generate positive cash-on-cash returns.
“We had a lot of trade buyers, who sold something at a low cap rate and are trying to replace it with something at a higher cap rate,” said Pollack.
The Morgan Stanley REIT research group is also showing some concern for the sector. In September the group lowered its outlook for the industry to “cautious” from “in-line.” A strengthening economy will make it increasingly difficult for REITs to continue outperforming the rest of the stock market, the group says. It also opines that REIT stocks are too expensive and that the run-up in Treasury yields has significantly reduced their relative attractiveness as an investment option. Further, investors are unlikely to continue putting huge sums into real estate mutual funds, it says.
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MARKET SCANNER
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The economy continues to show signs of a recovery, albeit a jobless one. In its most recent survey, the Department of Commerce reported that in July new orders for manufactured goods increased to $329.4 billion, a 1.6 percent gain. Employment figures, however, were not quite so encouraging. The Labor Department reported that first-time filings for unemployment benefits rose to 413,000 for the week ending Aug. 30, 2003, up 15,000 from the previous week’s revised figure of 398,000. From the first quarter to the second quarter, productivity in the business sector grew at a healthy 7.2 percent annual rate, while hours worked dropped 2.7 percent. |
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