With sustained yet slow improvements in the economy, the U.S.
Real Estate Investment Trust (REIT) industry outperformed the
broader equity market in fiscal 2011. The FTSE NAREIT All Equity
REIT Index reported total returns of 8.28% for full year 2011 vs. a
2.11% and (1.80%) for the S&P 500 Index and the NASDAQ
Composite, respectively. This was preceded by two solid
back-to-back fiscal performances for the industry, as the FTSE
NAREIT All Equity REIT Index reported total returns of 27.95% in
2010 and 27.99% in 2009.
A combination of factors has helped the listed REIT sector to stand
out and gain critical mass over the past 15 to 20 years, the most
notable among them being a healthy dividend payout. Total returns
of 8.28% for the FTSE NAREIT All Equity REIT Index in 2011 included
a share price return of 4.32%.
Investors looking for high dividend yields have historically
favored the REIT sector. Solid dividend payouts are arguably the
biggest enticement for REIT investors as 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 Equity REIT Index, as of December 30, 2011, was 3.82% compared
to 2.22% for the S&P 500 and 1.87% yield on the 10-year U.S.
Treasury Note.
During the 2007 to 2009 period, 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-return assets to
their portfolios.
Furthermore, REITs managed to raise capital to pay off debt, owing
to a large inflow of funds as institutional investors allocated
more 'dry powder' to the industry, making them an increasingly
attractive investment proposition. In 2011, REITs raised $51.3
billion in public equity and debt, out of which $37.5 billion alone
was raised though public equity despite a highly volatile market.
Moreover, according to data from NAREIT, leverage ratio of equity
REITs (total debt against market capitalization) as of September
30, 2011 was 41.6%, significantly lower than 51% at the end of
second quarter 2008, prior to the Lehman Brothers collapse due to
the 'Great Recession.' In addition, REITs typically have a large,
unencumbered pool of assets, which could provide an additional
avenue to raise cash during a crisis. These in turn have provided
the requisite wherewithal to the REIT industry to continue
outperforming the broader equity market over the past
quarters.
The standout performance in the REIT industry in fiscal 2011 was
that of the Self-Storage REITs (a total return of 35.22% as
measured by the FTSE NAREIT Equity REIT Index), followed by
Multifamily Apartment (15.10%), Health Care (13.63%) and Retail
(12.20%). The relatively underperforming sectors were
Lodging/Resorts (-14.31%) and Industrial (-5.16%) REITs.
OPPORTUNITIES
We are bullish on
Public Storage
(
PSA
), the largest owner and operator of storage facilities in the U.S.
The company has significantly increased the scale and scope of its
operations through the acquisition of Shurgard Storage Centers that
had a considerable presence in the European markets. Although
Public Storage currently owns a 49% stake in Shurgard, the size and
scope of its operations have enabled it to achieve economies of
scale, thereby generating high operating margins and managerial
efficiencies.
The 'Public Storage' brand is the most recognized and established
name in the self-storage industry with a presence in all the major
markets across 38 states in the U.S. In addition, the storage
facilities of the company have a high visibility and are usually
located in densely populated areas that improve the local awareness
of the brand. This offers a significant upside potential for the
company.
With a continued decline in the single-family homeownership rate
across the U.S., apartment REITs have performed strongly in fiscal
2011. We expect the performance of the multifamily sector to remain
comparatively stable in the coming quarters, as renting has emerged
as the only viable option for customers who could not avail
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 focusing 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 has the ability to fuel its expansion
drive though inorganic growth.
Another stock worth mentioning is
HCP Inc.
(
HCP
), a leading healthcare REIT with one of the largest and most
diversified portfolios in the healthcare sector having exposure to
nearly all types of facilities. The product diversity of the
company allows it to capitalize on opportunities in different
markets based on individual market dynamics, and provides a
hard-to-replicate competitive advantage over its peers.
In addition, HCP does not run the health care business at its
facilities. Rather, it has established business relationships with
a number of experienced healthcare management companies or
operators who lease these properties on a long-term basis -
generally for 10 to 15 years.
Healthcare is also relatively immune to the economic problems
faced by office, retail and apartment companies and is the single
largest industry in the US, based on Gross Domestic Product (
GDP
). Consumers will continue to spend on healthcare while cutting out
discretionary purchases. This insulates the company from short-term
market swings, and provides a steady source of income.
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
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
was the weakest performing segments during the economic downturn.
While the outlook for these markets has improved, the pace of
improvement remains quite uneven and unsteady.
The hotel industry is also cyclical in nature, and is heavily
dependent on the overall health of the U.S. economy. Unfavorable
macroeconomic conditions in the past has compelled customers to cut
back on discretionary spending and prefer lower priced brands over
premium ones. Consequently, demand for Host Hotels had reduced
comparatively and if the trend reoccurs in future, the bottom line
of the company is likely to be affected, reducing its operating
margins.
We also remain skeptical on
Cousins Properties Inc.
(
CUZ
) an REIT that acquires, finances, develops and leases office,
retail and industrial properties throughout the U.S. Cousins
Properties has a large development pipeline, which increases
operational risks in the current credit-constrained market,
exposing it to rising construction costs, entitlement delays and
lease-up risk.
Furthermore, Cousins Properties generates a significant amount of
revenue from its office portfolio. Office demand is highly
correlated to job growth. If job losses recur, operations in the
company's office portfolio are likely to suffer, thereby affecting
top-line growth of the company.
AVALONBAY CMMTY (
AVB
): Free Stock Analysis Report
COUSIN PROP INC (
CUZ
): Free Stock Analysis Report
HCP INC (
HCP
): Free Stock Analysis Report
HOST HOTEL&RSRT (
HST
): Free Stock Analysis Report
PUBLIC STORAGE (PSA): Free Stock Analysis
Report
To read this article on Zacks.com click here.
Zacks Investment
Research