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Analyst: REIT management understating troubled economy

In the wake of the Sept. 11 terrorist attacks, REIT management teams are hoping for a sharp, V-shaped economic recovery and are not discussing the more painful alternative of a longer-term recession, according to David Shulman, managing director of REIT equity research for New York-based Lehman Brothers.

The analyst’s remarks appeared in an Oct. 16 industry update distributed to investors and the media, and came on the heels of the annual NAREIT convention held in Chicago Oct. 10-12. The analyst described the mood of this year’s convention as subdued. "We would characterize many of the CEOs that we met with as being more reactive than proactive in the current environment," wrote Shulman. "Few companies have significantly altered business models other than assuming stricter underwriting standards, going for occupancy at the expense of rent, and enjoying historically low interest rates."

Schulman described attendance at the conference as modest, noting that a number of buy-side firms decided not to make the trip. "In sync with our war and recession note and earning revisions published on Oct. 2, most REIT management teams agreed with the direction — but not necessarily the magnitude — of our lowered projections and are generally giving out wider ranges for 2002 earnings guidance, " wrote Shulman.

Operating expense pressures mount

Property owners across all sectors will be facing significantly higher insurance premiums (increases of 100% or more) as a result of the Sept. 11 attacks, according to Shulman. "Fundamentally, insurers were mispricing terrorism risk. Policies renewed after Jan. 1 will exclude acts of terrorism. Heightened security programs will likely increase property security costs three to four times and will need to be distributed between tenant and landlord," wrote Shulman. "Ensuring a safe and secure environment for tenants is a fundamental responsibility for landlords, which cannot be compromised.

"Given the shortfalls at state and city budgets, we would expect increased property taxes to become a significant issue in 2002, which will add to operating cost pressures and limit landlords ability to hold or push rent," the analyst stated.

Apartments in a fast cycle

Contrary to the conventional wisdom, apartment companies were the first to warn of earnings shortfalls, wrote Shulman. "Put simply, too many apartment REITs were over-earning with occupancies above 95% and same-store rental growth significantly above inflation. As long as the economy remained ebullient, the earnings were intact, but the slowdown created an air pocket in apartment company earnings. Renters can quickly respond to weakening economic conditions by becoming roommates or moving back home with mom," wrote Shulman.

Mall fundamentals OK for the moment

Shulman stated that malls are showing resiliency even though holiday sales this season are expected to remain either flat or drop 3% to 4%. But if the fear of terrorism hits the malls, fourth-quarter holiday sales are at risk, the analyst added. Given the continued pressure on retailer margins, the fear of increased store closings is widespread, which may hinder the industry in 2002. "Fourth-quarter specialty leasing revenue, which accounts for 40% to 45% of the annual volume, should hold up," noted Shulman, "as tenants have already paid one month rent (non-refundable) and have already ordered much of the merchandise."

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