Once the darlings of investors, real estate investment trusts (REITs) are experiencing some trying times.
For the past several months—and especially over the last four weeks—REITs have been hammered on Wall Street as investors dumped the stocks amid growing concerns about the weakening U.S. jobs sector, anemic housing data, and Europe’s never-ending debt crisis.
Attracted by REITs’ high-dividend yields, which averaged 4 percent, investors initially viewed REITs as immune to the global markets. That confidence was short-lived, however, as investors worried that a global slowdown could tip the nation into a double-dip recession, affecting landlords’ ability to raise rents in the future and sign new leases.
“While there is some concern about REITs, four weeks does not a season make,” says Stephen R. Blank, senior fellow, finance at ULI. “REITs are now well capitalized, they’ve cleaned up balance sheets. But if you look at their macro performance, they’re stuck. America has been through a credit downgrade, there’s the European debt problem, and real estate fundaments have not improved to any extent. I think REITs got ahead of themselves and started to think they could take advantage of buying opportunities, but there are no opportunities.”
REITs that pay significant dividends will provide a floor for the industry, Blank forecasts. “Institutions and investors need income and gravitate to REITs,” he adds. “That will provide some stability.”
Talk of a double-dip recession as well as the overhang from the European debt crisis continue to unsettle the REIT markets, says Edward J. Pettinella, president and chief executive officer of Rochester, New York–based Home Properties, a multifamily REIT with operations primarily along the East Coast. Adding to the concern is that few expect any significant changes until after the 2012 election.
“There is a strong belief that Congress is going to be gridlocked until after next year’s election, so there are no near-term magic bullets to fix the economic situation,” he continues. “And the Federal Reserve is running out of rabbits to pull out of its hat.”
Pettinella says he expects that the recovery for REITs will be uneven. “I think it will be choppy for the next six to eight quarters,” he says. “In 2010, we thought the economic recovery would occur this year, but it didn’t. I still believe an economic expansion is in the cards, but it’s been delayed. I think 2013, 2014, 2015 could be excellent years for the economy and the REIT industry.”
Pettinella, who is a member of ULI’s Gold Multifamily Council, points out that it’s not all bad. Funds for acquisitions are readily available from Fannie Mae and Freddie Mac, for instance. “We can borrow money at low rates—4.3 percent for ten years,” he explains. “It allows us to buy properties that are very accretive with good unleveraged IRRs [internal rates of return].”
It’s not the end of the world, Pettinella emphasizes. “We still have strong occupancy in our business and multifamily REIT earnings are very strong,” he says. “Some investors see us as a defensive stock—we generally excel during times like this. We do not underperform as much as others.”
Even so, REITs are doing well in the current economic environment, but stock market volatility is probably the industry’s biggest problem, says Richard J, Campo, chairman of the board and chief executive officer of Camden Property Trust, an S&P 400 company that owns interests in and operates 67,452 apartments across the country.
“REITs have outperformed the S&P for the year, but the wide swings have concerned investors and companies,” says Campo. “REITs will perform as the economy performs. Strong job growth would increase demand in a limited-supply environment, increasing cash flow and prices, while a double-dip recession would have the opposite effect.”
The positive fundamentals are being driven by the dearth of new supply caused by the financial bust, the lack of new credit, and the uncertainty surrounding the economic and the political future, Campo explains, noting that demand has been increasing even in a slow-growth economy.
“There will be consolidation as strong companies take over weaker ones,” predicts Campo. “Over the next few years, massive amounts of real estate debt [will] mature. Owners will be forced to recapitalize properties with more equity. This will produce a robust transaction environment.”
So what should ULI members do over the next 12 to 18 months? Persevere, Campo says. “It will take some time, but I do believe the housing debacle will take two to three years to be settled,” he says. “You just need to wait it out.”