Neff on the future of REITs

Although John B. Neff claims to be retired, NREI found that his retirement is a busy one. In his spare time he is a University of Pennsylvania trustee (and manages the university's endowment equity), teacher at Wharton Business School and has written a book entitled John Neff on investing with S.L. Mintz, New York Bureau Chief of CFO Magazine. Before his retirement in 1995, Neff served as senior vice president and managing partner of New York-based Wellington Management Co.

Recently, we talked to Neff to get his perspective on the REIT market.

NREI: You write that REITs have been bruised, maligned, overlooked and misunderstood. Why have REIT share prices performed so dismally when real properties are performing so successfully?

NEFF: The reason REIT prices have performed so dismally in 1998 due to the industry's transgressions. They were doing deals all over the place and selling stock accordingly. In effect, they were providing so much supply of their individual stocks that it eventually overwhelmed and weighed negatively on the marketplace. Good performance in 1998 and 1999 was a combination of higher interest rates, which had some effect on yielding stocks such as REITs and a momentum-intent market where technology has been the only place to go. Others, like banks, have suffered from neglect.

NREI: Do you think the booming national economy has been a factor in property value and REIT stocks' performance?

NEFF: Of course the booming economy helped supply and demand relationships particularly for office space and apartments and maybe some others. The two markets I have been most intent upon are office and multifamily. The high rate of business success for office space has been good. So the balance between supply and demand has been positive, and rates on offices and multifamily have gone up, - not sharply, but have moved up kind of neatly and that always helps the P&L.

NREI: You say in your book that retail has not done very well.

NEFF: I am very dubious of retail because however real or unreal Internet pricing has been, it's very real in the sense that it's made an impact on retail. The retailer has the ability to get on the Internet and participate; but, the landlord doesn't. There is nothing worse than having bricks-and-mortar and no sales. It seems to me the Internet will have a very significant impact on retail.

NREI: So would you be cautious about any type of a retail REIT?

NEFF: Yes, more than cautious - not interested.

NREI: Do you think the asset value of commercial property has declined, thus affecting REITs? If so, why?

NEFF: I'd say it has gone up a bit - although not sharply. I'm not out there in the marketplace watching transactions but it seems to me that prices have held up.

NREI: You state that you are banking on exceptional [REIT] performance when the market shakes off the high-tech stupor. Why do you think REIT performance in the coming months is likely to be exceptional?

NEFF: The principle advantage that REITs bring to the marketplace is extraordinarily high yields. I was always a yield-interest generated, yield-intent investor. These days the S&P sells at a 1-1 yield. If you can get a 4% yield, that is good because it is a 300 basis-points advantage. In the REITs wave, you can get 7% to 10%, which is good and even if the stocks don't appreciate, which I think they will. That is a pretty good return when your banking a 7% to 10% dividend every year. It's like having a growing bond.

NREI: What, in your opinion, will it take for the market to shake off its desire for high-tech stocks?

NEFF: It is a little hard to point at anything precisely but, obviously, a few more bombs like Lucent and Gateway where their earnings dropped drastically, and investors will start looking elsewhere. In one day Lucent went down 25%. Drops like that will take the starch out of an area that's very, very momentum driven. The market has lost momentum in both those stocks.

Also, eventually things fall by their own weight. A comparison is in 1971 to 1973 when the so-called 'nifty 50' high-growth stocks were 40 times to 50 times higher than normal. With no more room to be upgraded they started to go the other way. They had a terrible 1974.

Some of those stocks never got back to their 1973 highs until seven years to 14 years later simply because they got too high. Cisco is a good company, which capitalized $350 billion and is selling at 100 plus earnings. That is just ludicrous by any thinking-man's standards. So eventually something happens and they just go the other way.

NREI: Why do you think high-tech stocks have taken off as much as they did initially?

NEFF: One, because they are new-wave or new-economy and two, obviously they have shown unusual growth.

High-tech has a high mortality rate. In almost all the other industries we've talked about nothing comes along to destroy you.

But technology moves so quickly you can find yourself in trouble. For instance, Compaq was down 35% last year. Being in technology didn't help.

NREI: What is the timetable for the market to come out from under this high-tech stupor?

NEFF: Well, we've already had a bit of a change this year. I don't know how to evaluate the timing but I will say it's has to happen, and probably sooner than later.

NREI: What are your thoughts on the REIT Modernization Act (H.R. 1180)?

NEFF: Positive. The act allows REITs to provide more services and get paid accordingly. We are in an age where there are more services to provide - particularly in technology.

NREI: What is the future of REITs for 2000 and beyond?

NEFF: Good. If you get 7% to 10% yield and a 7% to 10% growth rate that is a total return of 14% to 20% - a very reasonable multiple - that's hard to find in this bracket.

NREI: What will be necessary to improve REITs' standing?

NEFF: Crank out earnings, increase dividends and wear the market out. The market will eventually be attracted to the positives if you keep rendering them - like continuing to deliver growth and earnings and growth and dividends.

NREI: Some real estate professionals believe that what is happening with REITs is an indication that the market is going to take a downturn. What are your thoughts?

NEFF: The challenge is going to be if we get a serial re-evaluation of tech stocks. If 50% of stocks are tech stocks, is that going to discourage people from common stocks? Thirty percent of the S&P 500 are technology stocks now.

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