Real Estate Investment Mis-Trusts by Ian Wyatt (10-OCT-05)
They’ve been the investments dreams are made of. Real estate investment trusts (REITs) -- companies that invest in commercial and residential real estate properties in bulk and have offered wonderful returns for investors; at least until now.
Over the past three years, shares of REITS have increased by roughly 16 percent per annum, paying average annual dividends of about 7 percent, and – though price appreciation has slowed – the S&P REIT Composite Index is still up 6 percent for 2005; this compared with just a 1.39 percent increase in the S&P 500 and a 1.99 percent decline in the Dow Jones industrial average.
Yet, is all this about to change? Possibly.
Though the nice part about REITs is that, by law, they must share their extra earnings in the form of dividends, the problem with REITs is that they’ve been going up for so long their valuations are expensive, to say the least. Foreign investors have taken a shining to them given their high dividends and returns relative to other foreign investment vehicles, and institutional and retail investors here at home have figured that strong employment and even a modestly growing economy should keep rents high and occupancy rates full.
All true if we don’t factor in the new wildcard of higher energy prices that has some analysts seeing the potential for recession in 2006. Moreover, higher interest rates hoping to offset any future inflationary pressures are going to eat into REITs cost structures, mortgage expenses and ‘performance rent’ income, with higher energy costs and higher interest rates potentially impacting consumer demand overall.
This is especially true at the lower end of the market where lower income consumers seem to be feeling the pinch far more than affluent shoppers. Wal-Mart (NYSE: WMT) recently blamed higher fuel costs for reduced spending by low-income shoppers. And The Gap (NYSE: GPS) and The Limited, both retail clothing stores operating in shopping malls across the country, also reported disappointing earnings.
This wealth/spending bifurcation makes REITs specializing in luxury shopping malls, such as Simon Property Group (NYSE: SPG ), hot properties among investors. Shares of SPG have increased from $53 to $73 over just the last twelve months, though they are currently off their highs above $80 per share. In its second fiscal quarter, Simon was able to increase rents on new leases by 18.6 percent, up from 13.1 percent a year ago. This drives up Simon’s overall funds from operations (FFO) – the financial metric most REIT investors pay attention to – allowing it to trade at more than 15 times FFO, when most other mall operators are trading closer to 13 times 2005 FFO; still an all-time high for the industry.
Kimco Realty Corp (NYSE: KIM ) offers much the same story. Yet another mall operator that has benefited from strong consumer spending in select parts of the country, as well as Canada and Mexico, Kimco’s occupancy rate increased to 94.1 percent in its most recent quarter, up from a still strong 92.4 percent a year ago. Base rents for the same lease space increased by 13.2 percent, leading to such strong results that Kimco announced a 2-for-1 stock split in July as shares continued to climb to new highs at the split-adjusted price of $33.35.
Yet, second tier mall operators aren’t shining as brightly. Pennsylvania REIT (NYSE: PEI ) and Glimcher Realty Trust (NYSE: GRT ) do not own the same glitzy malls as KIM and SPG, and like their lower income shoppers, are beginning to feel the pinch of a tightening economy, an uncertain jobs pictures, and record high gasoline prices. Shares of PEI dropped precipitously from $50 to $42 over just the last two months, while shares of Glimcher sank from $30 to $24 since July.
Does all of this mean that the boom in REITs is over? Not necessarily. But investors should start asking themselves where, exactly, is the upside for the higher end REIT owners if valuations are already at historic premiums, while also remaining cautious of lower end property owners who are already seeing signs of weakening demand and reduced incomes among the less affluent shoppers of the world. When it comes to REIT’s, it might be difficult to trust where these ‘trusts’ are heading.
Best Regards,
Pete Henig
Market Columnist
Growth Report
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