When dealing with real estate investment trusts, it always seems like a case of good news, bad news. Seldom, however, do the two occur together.

Known for cyclical peaks and valleys that rival the most daunting of roller coasters, REITs at present are caught somewhat in the middle, with certain elements indicating that the industry is about to break out of a two-year fiscal funk and others suggesting that the sector still has a difficult road ahead in regaining favor among the investment community.

On the plus side, REITs are outpacing most other financial indicators in 2000, with the National Association of Real Estate Investment Trusts showing a 23 percent increase in total returns through the end of July in its “Public Equity 100” index. That barometer, which tracks the 100 largest publicly traded equity REITs, is well ahead of 10-year treasuries (6.7 percent) and the Russell 2000 Value Index (9.3 percent). When compared to the stock market, the situation is even better, with the S&P 500 down 2.6 percent, Nasdaq Composite at minus 7.4 percent, and the Dow Jones falling to a negative 8.4 percent.

“In terms of performance, it has been a very good year,” acknowledged NAREIT spokesman Jay Hyde. “Nothing else comes close.”

Indeed, in total returns, July was the best month for REITs since April 1999, and appears to indicate that the industry will reverse two years of negative performance, with REITs down 18.8 percent in 1998 and 6.5 percent last year.

NAREIT Director of Research Michael R. Grupe cited the uncertainty of corporate earnings in other investments, as well as the Federal Reserve’s interest rate policy, as reasons for the improvement in the REIT market. Many are becoming “less comfortable” with the valuations of some high-tech stocks, he said, while the prospect of regular quarterly dividends is also seen as helping to separate REITs from other alternatives.

“What has happened in other areas of the market this year is forcing investors to take a more sober view of what their investment decisions should be,” Grupe said. “They are beginning to think that their [portfolio] should not be 100 percent growth-oriented, that they might want to take a look at having a more stable mix.”

In some respects, Grupe said he believes REITs were a victim of their own success. Fueled by solid returns in an improving real estate market, the industry itself came to be seen as a growth investment in the mid-1990s, only to come crashing back to earth when the real estate home runs slowed in mid-1998.

“That was a special situation and people got confused in their outlook,” Grupe said. “What we are seeing now is much more normal.”

But while REITs do appear to be holding their own in terms of stock performance, observers caution that the capital markets still appear unswayed. George J. Fantini Jr. of Fantini & Gorga in Boston said he has been impressed by the returns being garnered, but added that will likely not transfer into an ability to raise money for new acquisitions.

“I think the mood of the REIT industry is better than it has been in the past year, but clearly it has not reached the point where they can go back to the capital markets and raise the capital they need,” Fantini said.

According to Fantini, REITs raised about $50 billion in new equity during 1997 via initial and secondary public offerings, but that figure has tracked down ever since to where Fantini said the industry “will be lucky” to reach $5 billion in 2000.

Banking institutions which previously issued lines of credit will not do so because of the difficulty REITs have in issuing stock, Fantini said, while the ability to refinance through pension funds and insurers is seen as risky because analysts take a dim view of the subsequent long-term debt amassed. From the prospect of raising capital, Fantini said he anticipates “a lackluster year” for REITs.

Investment broker Robert E. Griffin Jr. concurred with that outlook, noting that REITs have remained on the sidelines for most of 2000 when it comes to acquiring commercial real estate. “The majority of them are still quiet,” said Griffin, who estimated that upwards of 80 percent of REITs are inactive at present.

One anticipated phenomenon that has not occurred has been in the area of mergers and acquisitions among REITs. While many had predicted major consolidation among such vehicles in 2000, Grupe and others said that has not been the case. According to Hyde, there have been just three unions in 2000, compared to eight in 1999 and 14 in 1998. Grupe cited the cost of putting together such a merger as one reason for stunting that aspect of the market.

“I do think we will see further consolidation down the road, but it may take longer than people thought it would,” said Grupe. Whereas about 100 of the 199 publicly traded REITs currently control some 90 percent of the market capitalization, Grupe said that figure could eventually shrink down to 20 or 30 large REITs. The notion that many REITs would dissolve themselves, or de-REIT, has also not taken place, Grupe said, although MGI Properties of Boston is in the final stages of liquidating itself.

In the absence of mergers and acquisitions and growing through buying properties, Grupe said the REIT industry’s recent successes in the bottom line has been a product of creating greater efficiencies.

The crash “forced a lot of people to really shape up,” Grupe said. “They began to look inside their businesses rather than seeking external capital, and that’s a good thing.”

Despite Investor Concerns, REIT Returns Are on the Rise

by Banker & Tradesman time to read: 4 min
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