The U.S. Real Estate Investment Trust (REIT) industry has sustained
the improving trend this year, driven by a largely increased inflow
of funds as institutional investors allocated more capital to the
industry. This has helped the group generate market-beating
returns.
The FTSE NAREIT Equity REIT Index had total returns of 6.3% in the
first quarter of 2011 vs. 4.8% and 5.4% for the NASDAQ Composite
and the S&P 500 Index, respectively. This was preceded by a
solid back-to-back returns performances by the industry, as the
above referred benchmark index returned roughly 28% each in 2010
and 2009.
Investors looking for high dividend yields also favored the REIT
sector. Solid dividend payouts are arguably the biggest enticement
for REIT investors as the U.S. law requires REITs to distribute 90%
of their annual taxable income in the form of dividends to
shareholders. The dividend yield for the FTSE NAREIT All REIT Index
by the end of first quarter 2011 was 4.2% compared to 3.4% for the
10-year U.S. Treasury Note.
The standout performance in the REIT industry (as of May 24, 2011)
was that of the timber REITs (a total return of 15.43% as measured
by the FTSE NAREIT Equity REIT Index), followed by self-storage
(13.75%), diversified REITs (13.62%), regional malls (12.90%),
office (12.26%), apartments (11.90%), and mixed-use REITs (11.85%).
The relatively underperforming sectors were shopping-center REITs
(5.11%) and lodging/resorts (-2.63%).
A combination of factors has helped the group stand out. During the
crest-to-trough period of 2007 to 2009, REITs took on far less debt
than private real estate investors, and many were able to sell at
the top of the market when private equity investors were still
buying.
Importantly, during the downturn REITs were able to acquire
properties from highly leveraged investors at deeply discounted
prices. This enabled them to add premium high-returns assets to
their portfolios. Furthermore, REITs have been able to raise
capital to pay off debt, making them an increasingly attractive
investment proposition.
Since late 2010, mergers and acquisitions have gained pace, as
publicly traded REITs have benefited from access to the public
markets to fund transactions. Healthcare REITs had announced $11.25
billion worth of acquisitions in 2010, led by the $6.1 billion
purchase by
HCP Inc. (HCP), the largest medical
REIT in the U.S. HCP acquired ownership interests in 338
post-acute, skilled nursing and assisted living facilities from HCR
ManorCare Inc., a leading privately owned provider of skilled
nursing facilities.
Redefining the market dynamics,
ProLogis (PLD), a
leading global provider of distribution facilities, also merged
with its rival
AMB Property Corp. (AMB) in early
2011 in an all-stock deal, creating a behemoth of sorts in the
industrial real estate sector.
The combined entity would have a pro-forma equity market
capitalization of approximately $14 billion and a total market
capitalization of over $24 billion. The merged company will be
treated as an UPREIT -- an innovative business structure that forms
an umbrella partnership between property owners and REITs.
The developments indicate signs of stabilization in the commercial
real estate (CRE) market. According to data provided by Deloitte,
CRE transaction volume surged from $54.7 billion in 2009 to $122.7
billion in 2010 -- an increase of 124.3%.
The spurt in CRE transaction volume has also continued through the
first quarter of 2011, growing 69.5% year-over-year to $30.5
billion. Furthermore,
Jones Lang LaSalle
Incorporated (JLL), a leading full-service real estate
firm, anticipates direct investment in CRE to swell to over $350
billion in 2011 -- the highest levels since 2008.
OPPORTUNITIES
With a continued decline in the single-family homeownership rate
across the U.S. and gradual improvement in the overall economy,
apartment REITs have performed strongly in first quarter 2011. We
expect this sector to remain comparatively stable in the coming
quarters, as renting has emerged as the only viable option for
customers who could not get mortgage loans or are unwilling to buy
a house at present.
In this environment, we remain bullish on
AvalonBay
Communities, Inc. (AVB), one of the best-positioned
apartment REITs, primarily focused on developing multi-family
apartment communities for higher-income clients in high
barrier-to-entry regions of the U.S. AvalonBay has Class A assets
located in premium markets, such as Washington DC, New York City,
and San Francisco, where the spread between renting and owning is
still high despite home price declines.
In addition, AvalonBay has a reasonably strong balance sheet with
moderate near-term debt maturities and adequate liquidity.
Consequently, the company can capitalize on potential acquisition
opportunities due to distressed selling from owners and developers
who cannot refinance their properties, which augurs well for its
top-line growth.
We are also bullish on
The St. Joe Company (JOE),
an operationally diverse real estate company. St. Joe is the
largest private landowner in Northwest Florida, and is one of the
largest real estate developers of the region, engaged in town,
resort, and industrial development in addition to land sales and
commercial real estate operations.
The opening of the Northwest Florida Beaches International Airport,
developed by St. Joe, is the first new international airport opened
in the U.S. since the 2001 terrorist attacks, and is expected to
become a major growth driver for the region. The airport greatly
increases the future value of its holdings, and provides an upside
potential for St. Joe.
The company also launched Venture Crossings Enterprise Centre at
West Bay -- a commercial development spanning 1,000 acres adjacent
to the new airport, for industries, offices, retailers and hotels,
which will likely have a positive economic impact on the region in
the long run.
Another stock worth mentioning is
Plum Creek Timber Co.,
Inc. (PCL), a timber-REIT that owns one of the largest and
most geographically diversified private timberland in the U.S. Plum
Creek’s diversified timber and land base provides excellent
operational flexibility to respond to changing market conditions
amid challenging macroeconomic environment.
In addition, the upsurge in demographic trends driving housing
markets and demand for real estate properties across the nation
provides a strong economic backdrop for the company to demonstrate
solid financial performance in the future. The company is also
likely to continue to defer harvest and sell off non-core timber
assets in order to fund its dividend and maintain significant
liquidity. This defensive behavior seems appropriate given the
company’s stated objective of maximizing long-term value and
maintaining a stable dividend payout.
WEAKNESSES
A significant chunk of REITs are raising capital through property
level debt and equity offerings. Although both debt and equity
financings provide the much-needed cash infusion, they could
potentially burden an already leveraged balance sheet and dilute
earnings. Property level debt is also harder to obtain and more
expensive as commercial real estate prices remain under
pressure.
We are bearish on
Regency Centers Corporation
(REG), a self-administered REIT that owns, operates, and develops
grocery-anchored retail shopping centers in the U.S. Regency has an
active development pipeline, which increases operational risks in
the credit-constrained market, exposing it to rising construction
costs, entitlement delays, and lease-up risk. As such, we are
skeptical about the long-term earnings potential of the
company.
In addition, most of the REIT’s properties are concentrated in
select markets in California, Florida and Texas, leading to
concentration risk. Furthermore, the possibility of store closings
at many Regency stores adds uncertainty to earnings, and it might
have to re-let large big box spaces at significantly lower rents in
a tough leasing environment. This clouds the REIT’s earnings power,
which accounts for our negative view of the stock.
We also remain skeptical about the prospects of
Host Hotels
& Resorts, Inc. (HST), the largest lodging REIT and
one of the largest owners of luxury and upper-upscale hotels. The
majority of Host Hotels’ properties are concentrated in the luxury
and upper-upscale segments, which had been the weakest performing
segments during the economic downturn. While the outlook for these
markets have improved, the pace of the improvement remains quite
uneven and unsteady.
AVALONBAY CMMTY (AVB): Free Stock Analysis Report
HCP INC (HCP): Free Stock Analysis Report
HOST HOTEL&RSRT (HST): Free Stock Analysis Report
JONES LANG LASL (JLL): Free Stock Analysis Report
ST JOE CO (JOE): Free Stock Analysis Report
PLUM CREEK TMBR (PCL): Free Stock Analysis Report
REGENCY CTRS CP (REG): Free Stock Analysis Report
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