NEW YORK — New York--Real Estate Investment Trusts, or REITs, as the are commonly called, were the the scourge of banks and investors in the early 1970s and, like almost every other real estate investment, great for part of the past decade and awful for the rest.
Given the increasingly high vacancy rates in office buildings and factories, as well as the difficulty in selling a home, it would seem likely that they would be equally abysmal today. But in another curious facet of the recent broad bull market, that has not been the case for REITs (or for airlines, newspaper companies, banks and many other relatively troubled areas). Prices for what is known as equity REITs, or trusts comprising equity investments in pooled parcels of real estate, began recovering from a precipitous slide in January and have continued to appreciate since.
That has been true nationally (see chart) and particularly in the mid-Atlantic states. For example, shares of Washington REIT, which has substantial property holdings in the D.C. area, rose from 16 3/4 to 21 1/8 since the beginning of the year. Federal Realty Investment Trust, which has two shopping malls on Baltimore's fringe, rose from 14 3/8 to 18.
The significance of the move is broader than its immediate reward to investors because it suggests that the cataclysmic real estate woes that have wounded many homeowners and devastated many banks could be turning.
Any positive twist on the real estate market must be viewed in the context of an abundance of disconcerting evidence emerging at the moment. A study released last week by Landauer Associates Inc., a New York real estate consultancy, concludes that the amount of vacant industrial space swelled from 8.1 percent to 9.2 percent in the past year and that the office-space vacancy rate went from 17 percent to 19.9 percent. Consistent with the trend, the industrial vacancy rate for Baltimore rose last year from 15.2 percent to 20.9 percent and the rate for top-flight office space rose from 11.5 percent to 12.5 percent. Landauer's forecast for this year is gloomy.
But poor conditions tend to correct themselves in time. According to Catherine C. Creswell and Robert Frank, two analysts at Alex. Brown & Sons in Baltimore, that is starting to happen now.
The price for equity-oriented REITs may have reached the kind of bottom that only emerges every 15 years, they contend, despite the likelihood that during the next 12 to 24 months the value of industrial and office properties could continue to weaken and some shopping centers may be declared entirely worthless.
Why the turn? The initial reason may have more to do with financial markets over-shooting than expectations of a revival in real estate values. Ms. Creswell contends these trusts were simply oversold. An index of equity REITs declined roughly 40 percent in value between early 1987 and late 1990 before the modest revival this year.
The drop was far in excess of the decline in income the REITs were receiving from their real estate holdings and were remitting to shareholders. As a result, the average yield on an equity REIT rose from 9 percent to 10 1/2 percent at the same time that the yield on the benchmark 10-year government bond was falling from 9 percent to 8 percent.
"Even if the market corrects, [REITs] won't decline to where they were because they were just too low," Ms. Creswell said.
The more interesting aspect of the turn, however, is that the factors that have undermined real estate values and rental charges could be over. As the 1980s began, substantial tax incentives existed to encourage construction. That stimulated numerous projects that may have been uneconomic on an absolute basis but were nonetheless palatable for some investors because the projects shielded income from taxes.
The major overhaul of taxes in 1986 eliminated much of this incentive, however, and studies by both Landauer and the New York investment bank Salomon Bros. indicate the dollars devoted to construction, and the square feet included in con
struction contracts, have subsequently declined.
"The incentive to build was lost," said Ms. Creswell, if the expected result couldn't be leased at profitable rates.
But because of the lag between when projects begin and are completed, a heavy supply of new buildings has continued to come onto the market. Even though that has moderated, the recession has meant many businesses have reduced their demand for space.
But even with the pileup, Ms. Creswell said, a reversal is coming into sight. Not only are the tax-based deals dead, but banks aren't lending for real estate, and investors are requiring higher returns. The first area to see tightening has been apartments. Construction has declined 50 percent since 1985, and the surplus is down everywhere but the Northeast.
Despite the slow economy, apartment vacancy in the Southeast, the most overbuilt area, has dropped from almost 12 percent to 9 percent in the past three years. Next to tighten up will be industrial space and then office space by about 1995.
"There is just so much office space in the market, it will take longer to get it out but eventually it will happen," Ms. Creswell said, first in areas with low taxes and good supplies of workers and other incentives for business, such as the mid-Atlantic and Southeast, last in the Northeast and certain areas of the West Coast where taxes and expenses are high.
The least predictable area is retail. For the better-positioned malls and shopping areas, prospects are tied to the shifts of consumer spending. For other areas built in the enthusiasm of the 1980s, no turnaround may ever come.