Real Asset Backing a Plus for REITs

Although the credit crunch has impacted the real estate investment trust sector, REITs are still able to access funds and offer investment opportunities, according to a New York REIT conference sponsored by the New York Society of Security Analysts.

At a panel session that focused on the outlook for REITs moderated by NREI Editor Matt Valley, Steven Marks, managing director of Fitch Ratings, noted that liquidity has largely dried up. John Coumarianos, a Morningstar equity analyst, however, pointed out that even then REITs have other ways of accessing capital. For instance, United Dominion Realty Trust recently sold over $1 billion worth of property. REITs can tap joint venture opportunities and funding is also available from Fannie Mae and Freddie Mac, though it is not clear how much.

As for the question of whether commercial real estate prices are going to drop as much as 20% in value — a view held by Goldman Sachs — Coumarianos said that “everyone is scared about any kind of building,” adding that the supply situation is not as bad on the multifamily side as it is on the single-family side. Brad Case, vice president of research and industry information for the National Association of Real Estate Investment Trusts, observed that it would be tricky to apply this sort of outlook across all properties.

To the extent that property values have declined, it is because they were not valued correctly in the first place, said Case. For instance, some companies borrowed money to invest in properties without careful review of their fundamentals just to please their investors. Marks expects that a decline in property values of 20% to 25% is unlikely, and is more possible in the softer markets.

One issue that has emerged is how multifamily REITs have been impacted from the competition from condo properties that have been converted to rentals. Coumarianos noted that up until a year ago rents were rising in places like California, whereas in the current environment landlords can’t hike rents so much. He believes that rent growth could also be decreasing because job growth is slowing.

Case sees hotel properties as more prone to fluctuations in supply whereas other property types move more closely together. And multifamily properties have been the only REIT sector in which returns have been going up steadily since December according to Coumarianos, and they could have hit a bottom before the rest of the market. The expectation is that people who are looking for further declines in home prices will continue renting and stash their belongings in self-storage facilities, which is good for the performance of these two property types.

Another topic of discussion was the tendency of REITs to enter into joint ventures and the impact of this on performance. Fitch Ratings looks at such partnerships on a case-by-case basis, Marks said, and judges the impact depending on the outcome at the time the joint venture winds up. Coumarianos noted that joint ventures are more likely as capital becomes tight and this also makes the accounting a bit more difficult. Case noted that a number of REITs have toyed with diversified revenue streams through other arrangements, such as commingled funds arrangements, for a while.

Touching on the increasing globalization of the REIT format, Case said that while investors are “wild about global investing” they need to understand the various REIT models. For instance, Canadian and Australian REIT models are similar to the U.S. model whereas the Asian model is different since commercial real estate markets are not fully developed there. Asian REITs tend to focus more on development opportunities and the expectation is that they will produce higher returns to compensate for the higher volatility involved in these situations. Over a period of about two decades, he expects to see convergence between U.S. and overseas REITs as they become more similar.

The analysts believe that however bad the outlook gets, REITs are a good bet because they are backed by real property. They have assets to sell and it is difficult for a REIT to go “completely belly up,” according to Coumarianos. Indeed, Case noted that there has never been an equity REIT that went bankrupt. Through cycles REITs haven’t had problems accessing cash, according to Case. In fact, the people having trouble getting money in the capital markets today as those “who don’t have much to offer,” such as Bear Stearns. It is difficult to get favorable terms on risky loans.

In a recessionary environment, the analysts expect retail properties to be better positioned than other property types, with necessity-based retail — such as grocery-anchored strip malls — more so than those tied to discretionary consumer spending. As for individual REIT stocks, Coumarianos favors First Potomac, a Washington, D.C.-based industrial REIT whose biggest tenants are the federal government and their contractors. In the retail sector, he likes Developers Diversified Realty Corp. He also sees opportunity in three office REITS — Vornado, Brandywine, and Mack-Cali.

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