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Zacks Analyst Interviews

Real estate investment trusts, or REITs, have been among the hardest-hit sectors in the overall market since the credit crunch hit. Is now a time to be considering picking up some REIT holdings on attractive valuations? We spoke with Zacks senior REIT analyst Greg Sukenik to find out.

Around the time of our last interview, you were advocating apartment REITs. Are you still strong on this sector?

I still like apartments, as I think they will continue to outperform other sectors in the 1st half of 2009. Housing will not be coming back anytime soon, and it is still difficult to obtain mortgages with less than 20% down, so there are more renters.

Although, with job growth negative in most markets in the US, it will be difficult for landlords to increase rental rates. Most apartment companies are lowering or holding rental rates steady in an attempt to stop vacancy increases. Overall earning growth in 2009 will be negative or flat for most apartment REITs that we cover, although we still think this sector will fare better than many retail or office names.

Is it still a matter of buying companies with sustainable capital and avoid those that are highly leveraged, regardless which REIT sub-sector we're talking about?

Yes. In this environment it is much more difficult to rollover debt, and lenders are becoming much more selective about the deals that they will look at. In any sector, make sure the company has low-to-moderate near-term maturities, at least through year-end 2009.

Companies that took on a lot of leverage over the past couple of years have seen their stock prices decline more than sector averages. Until the credit markets straighten out, look very carefully at a company’s balance sheet and liquidity.

REITs are also known for their dividend yields, but do you see those shrinking in tougher market times?

REIT yields are now averaging over 8%, the highest in about five years. Some REITs have already cut their dividends, and more will in 2009 as companies try to conserve capital. Look for companies that are covering their payout with AFFO (adjusted funds from operations), which is a sign that a company is covering its payout with operating cash.

Companies that are AFFO-negative, or companies with large unfunded development pipelines are more likely to cut their payout. Although, a dividend cut is not always bad, as it is a good way for companies to conserve capital until liquidity returns and capital markets stabilize.

Do you see commercial real estate following the patterns of residential? Are we going to start seeing a wave of foreclosures?

Loan delinquencies in commercial real estate are definitively picking up, and this will continue in 2009. With less debt capital available and a weakening economy on all fronts, cap rates are rising and commercial property values are decreasing. There are many overly leveraged investors that piled on debt in the boom years and are now underwater. That is, their properties are worth less than what they paid, similar to the situation in residential.

So we do expect foreclosures to increase significantly, and some private developers and owners will get into trouble. Large, public REITs have for the most part had more discipline -- although there are some exceptions -- and have not piled on too much debt. These companies will be able to weather the downturn, and there could be some attractive buying opportunities for well capitalized REITs who can take advantage of distressed selling.

One big difference between this real estate downturn and others is the lack of overbuilding. Commercial real values and fundamentals are declining due in large to problems with banks and credit markets, not because developers built too much space. So we think it will be easier for commercial real estate to make a comeback once the credit markets are straightened out.

What is your outlook going into 2009? Have REITs reached a bottom?

We think the sell-off in REITs, and a lot of other sectors, has been overblown. So yes, we think REITs have reached or are close to reaching a bottom. The market is no longer trading on fundamentals, but on fear. The credit markets will stabilize, the government bailout with leave the headlines, and things will get back to normal.

Now is a good time to get into REITs at heavily discount prices. While earnings will be depressed in 2009, many REITs are now trading at significant discounts to the value of their assets, which is a good buying opportunity. Yields on some of the best, safest REITs are now in excess of 6%, an exceptional return in this economy.

Which would be your top Buy recommendations these days, and why?

There are some great values out there and most REITs are now trading well below NAV [net asset valuation]. In a very uncertain operating environment, we like the larger, “blue chip” companies with large portfolios, geographic diversification and strong balance sheets.

For apartments, we like Equity Residential (EQR - Analyst Report). EQR is the bellwether apartment REIT, the dividend is safe, and the company represents good value after the October sell-off. In the retail sector, we like Regency Centers (REG - Analyst Report). REG is a grocery anchored strip REIT with assets in high income, high growth locations. The company is somewhat protected from an economic downturn through long-term leases, and the company has low debt.

Are there any Sell-rated REITs under coverage investors should be warned to stay away from?

We still have a Sell on St. Joe Company (JOE - Analyst Report). JOE is a residential developer based in Florida. While the company has vast land holdings, we just don’t see the residential segment getting back on track in Northwest Florida in 2009. There was just too much overbuilding and price declines will continue.

We also have a Sell on Cousins Properties (CUZ - Analyst Report), an office and retail developer with asset concentrations in the Southern US. We think suburban office landlords are going to have a much more difficult time in 2009 and vacancies will increase as corporations are for the most part not taking on new space. Also, the company is not funding its dividend from operations, and we expect a cut.

Greg Sukenik is a senior analyst covering the real estate investment trust sector for Zacks Equity Research.

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