Highlights include Avalon Bay Communities, Inc. (AVB
) and Vornado Realty Trust (VNO
Equity REITs posted somewhat of a comeback last week after a rough 1st quarter. So far in March, REITs have rebounded 7% (total return FTSE NAREIT Index). All sectors are up in March; the best performing sectors were apartments (16% return), industrial (16%), and lodging (15%).
Overall, REITs are still down 30% so far in 2009, well behind the S&P and Dow. The March mini-rally is nothing to get excited about, and the sector could continue to sell off. Here's why:???
- 1) REITs still depend on access to debt to fund growth, and with the credit markets still frozen, it will be difficult for companies to raise cheap debt?? ?
- 2) Going forward, many REITs will raise capital through property level debt and dividend reductions. Property level debt will be harder to obtain as commercial real estate prices continue to plummet, which decreases the amount that a company can borrow and increases LTVs (loan-to-value ratios). Dividend reductions make the sector less attractive to income-oriented investors?? ?
- 3) REITs will be dependent on asset sales to raise cash. Overall commercial sales volumes decreased in 2008, and going forward it will be difficult to unload assets. Buyers simply cannot get financing?? ?
- 4) Commercial real estate delinquencies are ticking up at a fast pace, which makes lenders nervous about exposure to the CRE sector. Many companies in our coverage universe have cut dividends or decided to pay a large portion of dividend in stock in an effort to keep as much cash as possible. We are negative on stock dividends; companies want to keep cash and give investors cheap shares which dilutes all holders?? ?
- 5) Equity issuance at this time would be dilutive since many companies are trading at depressed prices
Then again, there are still some positives:???
- 1) Most REITs are trading at large discounts to NAV (net asset value), a good buy signal. Historically, over the past 7 or so years, REITs have traded near or in excess of NAV?? ?
- 2) Even with dividend cuts, the average yield for equity REITs is still over 9%. Yields are well in excess (600bps+) of the 10-year Treasury?? ?
- 3) If commercial real estate fundamentals do not fall off a cliff and follow residential into the abyss, then there could be some attractive long-term buys
There are some big ifs -- namely, if the various stimulus plans and bank bailouts actually work and stop the bleeding in employment and get banks lending again, then the outlook could get better, and there are some attractive beaten-down stocks. So far, the TARP has not caused the big banks to significantly increasing lending, as far as we know, because bailout recipients will not say where the "taxpayer" money is going. The stimulus plan will take months or even years to reverse negative employment trends.
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In this environment, we like well-capitalized companies that have adequate liquidity to fund debt through at least 2009. One name we still have Buys on is Avalon Bay (AVB), an apartment REIT with low debt and assets in infill markets where little new supply will be coming on board. Fannie and Freddie are still heavy lenders for apartments, which gives the sector access to relatively cheap capital.
In addition, we like Vornado (VNO), another company with low comparative debt, lots of cash and class-A office assets in some good long-term, heavily supply-constrained areas.
The credit freeze will have a good effect on these sectors down the road; new office and apartment construction has almost come to a halt, which should benefit these companies in the next couple of years. In fact, a handful of companies has ceased all new development starts in 2009.
These are long-term buys -- headline risk will cause continued volatility in the entire sector. Buy REITs for the yield, and expect share prices to be choppy until there is some evidence that some of the hundreds of billions of dollars the government is printing will help the country come out of the recession.