The U.S. Real Estate Investment Trust (REIT) industry has carved
a niche for itself and is now an important part of the overall
economy. Amid the low interest rate environment following the
financial crisis, the demand for REIT stocks has risen owing to
their ability to deliver steady income. Moreover, they help
investors benefit from their capital appreciation opportunities.
The U.S. REIT industry delivered a solid 2012 overall, with a
relatively strong run in the first half of the year followed by a
modest second half. Furthermore, REIT stocks have outperformed the
broader equity market in 2012 for the 4th straight year.
For full-year 2012, the FTSE NAREIT All REITs Index reported total
return of 20.14% and the FTSE NAREIT All Equity REITs Index
returned 19.70% compared to 16.00% for the S&P 500. The robust
results for 2012 comes after FTSE NAREIT All Equity REITs Index
delivered returns of 8.28% in 2011, 27.95% in 2010 and 27.99% in
2009 compared with the S&P 500's return of 2.11%, 15.06% and
A Closer Look
A combination of factors has helped the REIT sector stand out and
gain strong foothold over the past 15 to 20 years, the most notable
among them being a healthy dividend payout. As a matter of fact,
investors looking for high dividend yields have historically
favored REIT stocks. 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 of the FTSE NAREIT All REITs Index came in at
4.38% as of Dec 31, 2012 while the dividend yield of the FTSE
NAREIT All Equity REITs Index reached 3.51%. Moreover, the dividend
yield of the FTSE NAREIT Mortgage REITs Index was 12.93% as of that
date compared with the S&P 500 dividend yield of 2.22%.
During 2007 to 2009, REITs took considerably 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 heavy discounts. 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.
In 2012, REITs have surpassed the prior year figure and raised an
aggregate of $73.3 billion in capital, which included $45.8 billion
in secondary equity common and preferred share offerings, $25.7
billion in unsecured debt offerings and $1.8 billion in initial
Moreover, according to data from NAREIT, debt ratio of equity REITs
(total industry debt as a percentage of its total debt and equity
market capitalization) by the end of third quarter 2012 was 33.8%
-- significantly lower than about 51% prior to the collapse of
Lehman Brothers in 2008.
In addition, REITs typically have a large unencumbered pool of
assets, which could provide an additional avenue to raise cash
during a crisis. These assets, in turn, have provided the requisite
wherewithal to the REIT industry to make strategic acquisitions
over time to fuel its inorganic growth engine.
Going forward, we believe M&A opportunities will increase in
the current low interest rate environment. Particularly the REITs
with a solid balance sheet and reasonably better accessibility to
capital are expected to capitalize on such opportunities. In the
latter half of 2012, we noticed an increase in such deals and we
believe the trend will continue in 2013 as well. However, ambiguity
in the market may limit the tempo of the deals.
The Current Scenario
The January data was a little disappointing as the FTSE NAREIT All
REITs Index gained 4.28% compared to 6.24% for the S&P 500.
There were minor hiccups in the GDP growth rate of late, but we
noticed that households and business spending has been accelerating
and unemployment rate has been declining.
The European crisis has yet to resolve and given the current fiscal
conditions, the interest rate is expected to remain low for an
extended period. This, ideally, increases the demand for the REIT
stock that offers steady income.
Though the economic uncertainty and particularly the political
situation have been major factors affecting the market, we believe
that with the economic recovery gaining momentum, rents and
occupancies for most types of properties would improve further.
While a sluggish growth rate in jobs as well as closure of chain
stores is likely to pose a concern for the Retail sector REITs,
limited supply of new ones is expected to help increase the demand
for the existing ones and drive up their rental rates.
In the Apartment sector, though on the whole there have been
improvements, yet minor hiccups remain with an increase in supply
in certain markets. Industrial sector is projected to benefit from
the improving economy while the Timber sector's performance would
gain from an increase in new construction. In a nutshell, the
long-term prospects of the REIT industry look favorable with a mild
Sector Performance in 2012
In 2012, most of the sectors in the REIT market performed well and
reported double-digit returns. The standout performance in the
industry was that of the Timber REITs (a total return of 37.05% as
measured by the FTSE NAREIT Equity REITs Index, followed by
Industrial (31.28%), Infrastructure (29.91%), Retail sector
(26.74%), Health Care (20.35%), Self-Storage (19.94%),
Lodging/Resorts (12.53%) and Diversified REITs (12.20%). The
relatively underperforming sector was Residential (6.94%).
We are bullish on
Simon Property Group Inc.
), the largest publicly traded retail REIT in North America, with
assets in almost all retail distribution channels. Its
international presence gives it a more sustainable long-term growth
story than its domestically focused peers. The geographic and
product diversity of this Zacks Rank #2 (Buy) company also insulate
it from market volatility to a great extent and provide a steady
source of income.
In addition, Simon Property generally enters into long-term leases
with companies, which insulate it from short-term market swings
that have weighed on other players in the industry. With a
favorable supply/demand relationship, rising earnings estimates,
robust growth projections, and a healthy dividend rise (announced
simultaneously with its fourth quarter earnings release), Simon
Property offers an enticing upside potential going forward.
We are also bullish on
Taubman Centers Inc.
), which owns, develops, acquires and operates regional and
super-regional shopping centers throughout the U.S. and Asia. This
Zacks Rank #2 (Buy) REIT focuses on dominant retail malls that
command the highest average sales productivity in the U.S.,
measured in terms of mall tenants' average sales per square foot.
Furthermore, the shopping centers are located in the most affluent
regions of the country, thereby enabling retailers to target
high-end upscale customers and maximize their profitability. This,
in turn, has enabled Taubman to command relatively premium rents
for its portfolio, thereby ensuring steady top-line growth. In
addition, Taubman has one of the strongest balance sheets in the
sector with adequate liquidity. The company has also taken prudent
steps to reduce its operating expenses.
Another stock worth mentioning is
), a leading healthcare REIT, primarily engaged in the business of
financing, owning and leasing healthcare related and senior housing
Being one of the largest healthcare REITs in the U.S., this Zacks
Rank #2 (Buy) REIT boasts a significantly diversified portfolio and
exposure to nearly all types of facilities. Also, the healthcare
sector is relatively immune to the downturn in the economy, and
provides a steady source of income that protects the company from
short-term market volatility.
We expect the company's strategic move in acquiring Atria and other
opportunities to provide significant upside potential to the stock
going forward. Moreover, we remain encouraged with the recent
dividend hike announcement at Ventas.
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.
Although overall market fundamentals remain positive for Apartment
REITs, we are a tad bearish on
BRE Properties Inc.
). This Zacks Rank #4 (Sell) REIT is one of the leading owners and
operators of multifamily apartments with a strong portfolio of
assets in supply-constrained premium markets of the Western U.S.
The company is currently restructuring its portfolio and targeting
non-core markets for assets dispositions. Moreover, it expects to
fund the current development pipeline with proceeds from assets
sale. Notably, the key strategic motive is to remain focused
primarily on the targeted
high-barrier markets and sub-markets in California and Seattle, WA.
Despite attempts to reposition its portfolio, much of the company's
portfolio still resides in some weak multi-family markets, which
together make up nearly 41% of the company's same-store portfolio.
Another bearish stock is
), an apartment REIT that owns, operates, acquires, develops and
renovates middle-market apartment communities.
This Zacks Rank #4 (Sell) REIT faces intense competition across all
its markets from real estate investors, including insurance
companies, pension and investment funds, public and private real
estate companies as well as REITs. This affects the top-line growth
of the company and puts considerable pressure on maintaining its
profitability through stringent cost-cutting measures.
Moreover, though the recent employment trends are improving, they
are not yet back to pre-recession levels. The U.S. economy still
continues to shed jobs in some sectors. This, in turn, might exert
pressure on the occupancy rates, affecting the rental revenue of
the company, thereby hampering its long-term profitability.
Moving forward, limited supply of new construction coupled with the
growing demand for high-quality properties bode well for the
earnings prospects of REITs, in particular for those that have
assets in high barriers-to-entry markets. To sum up, we firmly
believe that despite a few pitfalls, given the current recovery of
the economy as well as the low interest-rate environment, REITs
still offers a worthy investment proposition for 2013.
SIMON PROPERTY (SPG): Free Stock Analysis
TAUBMAN CENTERS (TCO): Free Stock Analysis
VENTAS INC (VTR): Free Stock Analysis Report
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