After the fall and rise of REITs, what should we expect?

The Outlook

September 27, 1998|By Kristine Henry

INVESTORS in real estate investment trusts have been holding on to their hats. After plunging about 25 percent this year, REITs began rallying last week. Why did REIT stocks fall and why are they on their way back? What does it mean to the real estate market?

Martin Cohen

President, Cohen & Steers Capital Management, New York, with $5 billion in REIT holdings

REITs just experienced the strongest rally that they've seen in years. Up until a few weeks ago, we were in a bear market, and they recently bottomed out and started a very strong rally.

I think in the bear market the selling was overdone. Valuations were incredibly cheap, cheaper than they've been since 1990, yet the fundamentals were still very strong.

The dividend yields were high, over 7 percent, and they're still around 7 percent with a 5 percent Treasury market.

The real estate markets were on their way to experiencing some excesses with new development and prices were high. The decline in shares of REITs essentially shut off capital to the real estate market, and it corrected what could have been an imbalance.

More capital means more building and higher prices for real estate. That all came to a halt essentially when the capital markets shut off that flow.

At that point, REITs began to rally. We are no longer suffering excesses, and the cycle eliminated the possibility of there being a real estate bust.

Marsha J. Camp

Equity analyst, A. G. Edwards, St. Louis, Mo:

I wouldn't say we're necessarily out of the woods with REITs. The pendulum was swung too far in terms of value and the pendulum is swinging back. We think it's appropriate.

The main industry fear that took stocks down was the fear of overbuilding and acquisition prices being bid up too high. REITs have more than corrected.

It took a lot of players out of development and acquisitions, so it's almost been self-correcting. With stock prices at pretty lofty levels in '98, REITs were getting ahead of themselves. Returns were at 30 percent in '96 and 20 percent in '97, and you can't keep that on year-in and year-out.

We've called for 12 to 15 percent annually from REITs, and they've exceeded that. The market acted as it should -- it penalized a group for getting overheated.

Michael Mueller

Associate analyst at Donaldson, Lufkin & Jenrette

We downgraded the group in February. [Tuesday] We upgraded it from market perform, which is basically a hold, to outperform, which means buy.

If you look at the real estate property market, it's coming toward equilibrium. In the early and mid '90s, we had a bull market and property fundamentals were improving, occupancy and rents were going up and REITs benefited.

In recent years, occupancies were full and the fundamentals are plateauing. The returns expected from investors needed to be more modest than in the past; i.e., you can't expect 30 percent returns from REITs anymore, you should get mid-teens.

It's essentially a realignment of expectations. People who were looking for higher returns were moving out, and that essentially drove REIT prices down.

Now two things are going on: Stocks were beaten down and are cheaper, and the second thing is that capital has been turned off.

REITs haven't done nearly as many secondary offerings. The commercial mortgage-backed securities market essentially blew up and the spreads widened. We're not seeing money from the debt side flow back into the market.

I think it's positive for real estate prices. It could create some better buying opportunities for REITs. It's more of an attractive environment for REITs to operate in. We think those are the primary catalysts for the stocks going up.

Brenda Wood

Analyst, BT Alex. Brown Inc., Baltimore

People have two concerns: One is that REITs were paying too much for properties, and the next industry concern was the fear of overbuilding.

The rally has really been in the past week, and what happened was REITs dropped so far down that they became value stocks. The dividend yields are higher now than they've been in many years.

In addition, the dividend payout ratio has been very low. The combination of these two things is wonderful for investors.

They can get the stock for a good price, get a good return and the safety of the dividend is very, very good.

All that is very positive, and people are beginning to realize that and started to move back into the stocks. I think people felt they got a little bit inflated in 1997.

We think it's going to be a slow and steady increase in the price of stocks.

Not all stocks will increase by the same amount; there will be more of a differentiation now, and it will favor companies that are true operating companies -- not just ones that know how to buy real estate, and that's all you needed to know for the past three years.

Hopefully we'll have new construction that is a function of demand for that type of space vs. new construction because some bank is willing to give you the loan. That's very good for the market because it means that only projects that make sense will get built.

We're saying a midteen total return is what investors should expect. People were expecting the 26 percent returns they had seen, and that was hurting the stocks because they couldn't possibly deliver.

Pub Date: 9/27/98

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