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U.S. Market Turmoil Drives Interest in Global REITs

Global REITs could provide a safe haven during turbulent economic times in the U.S., according to Boston-based Torto Wheaton Research. During a research presentation on Tuesday—following the weekend’s tumult with investment banks Lehman Brothers and Merrill Lynch , the group praised REITs for continuing to outperform other equities and offering attractive valuations for those seeking alternatives to direct investment in real estate.

“The global REIT market today [contains] some of the largest, most liquid, pure play real estate companies; they have some of the finest properties in the world,” said W. Steve Carroll, managing director and co-chief investment officer for global real estate securities with CB Richard Ellis.

Looking internationally may be a good idea right now. The past two weeks brought in quick succession federal takeovers of government-sponsored enterprises Freddie Mac and Fannie Mae and insurance giant AIG; the bankruptcy filing of Lehman Brothers and the acquisition of Merrill Lynch by Bank of America. All of those developments raise questions for commercial real estate and could potentially depress property values in the U.S. further. Both Lehman Brothers and Merrill Lynch were lenders of commercial mortgages, investors in commercial mortgage-backed securities (CMBS) bonds and direct holders of real estate. (Lehman’s portfolio is estimated at $32.6 billion.) AIG too invested in bonds and real estate and provides insurance to commercial real estate firms. Fire sales by any of the firms could set the bar low for established values for direct real estate and CMBS bonds. That uncertainty has been reflected in various metrics. U.S.-based REIT stocks plunged by as much as 15 percent on Monday. Many recovered on Tuesday, but were down again in trading as of mid-day Wednesday.

Meanwhile, spreads on AAA rated commercial mortgage-backed debt on Tuesday rose to 318.81 basis points, according to Bloomberg, the highest level on record.

It is in this context that the research firm pointed out that global REIT stocks have offered returns of up to 14 percent on a five year basis through August 2008, versus returns of approximately 11 percent for global equities and 4 percent for bonds. On a risk-adjusted basis, REITs have produced returns of 0.6 percent per month over a 10 year period compared to 0.1 percent per month for both equities and bonds.

Moreover, Carroll said investment funds in today's climate look at REIT stocks as a real estate plays than as an equities investments. That’s more in line with the traditional approach investors have had to REIT stocks and unlike the REIT bull run from 2001 to 2007, when REIT stocks behaved more like traditional equities.

Part of the reason for the attractiveness of REITs is the diversity that can be attained. Carroll estimates a $2 million investment spread between REITs could provide exposure to 60 companies across all real estate sectors spanning 13 countries around the world and more than 3,000 institutional real estate properties. To achieve comparable exposure to institutional grade real estate through direct investment would require more than $1 billion, he said.

The drop in REIT prices over the past year, with a 25 percent estimated discount to net asset value, makes REITs all the more attractive. Global REITs offer an average dividend yield of 4.6 percent, with an 8.5 percent average cash flow growth on a two-year basis and a 7.4 percent cap rate. And, REITs, traditionally offer low debt to capitalization ratios; an average of 34 percent.

“As we look at [real estate] fundamentals across the globe, we see them as pretty solid,” said Raymond Torto, global chief economist at Torto Wheaton. “The big thing is that there is not a lot of new construction coming into the market; particularly in the U.S. When I talk to investors, they say their cash flow is terrific.”

Although the retail sector in the United States is experiencing challenges, Europe’s retail sector is particularly attractive.

“We do believe it is a compelling time to invest in global REITs, with a mindset of prudence to begin with a staged investment over the next three, six, nine months,” Carroll said. “Valuations look very, very attractive today, relative to the long-term average.”

--Elaine Misonzhnik

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