Real Estate Investment Trust (REIT)

With a broad-based sell-off in 2008, many REITs are trading well below net asset value [NAV], and average yields now exceed 6%.  Volatility will remain in the coming months as commercial real estate re-prices to account for the new reality of constrained credit and weaker fundamentals.

Some thoughts by sector:

Retail outlook: neutral
Consumer spending will continue to slow, and Christmas 2008 could be one of the worst for retailers in years. We like shopping-center REITs over high-end mall companies. Mall companies have more exposure to discretionary, higher-end retailers who could get hurt most as consumers curtail spending. There are some good buys in this sector based on valuation.

Apartment outlook: positive
Apartment REITs are one of the best-performing REIT sectors in 2008. Apartment landlords have benefited from the rapid decline in home sales, which has created a larger pool of renters. This will continue, although more and more houses and condos are being rented, adding competition. Look for rental rate growth in the sector to slow or stop; landlords will no longer be able to put through rental increases due to tapped-out customers.

Industrial outlook: neutral
Industrial REITs are one of the worst-performing sectors of 2008. Large industrial REITs depend on merchant building gains to drive FFO [funds from operations] growth. Merchant building profits could dry up as institutions shy away from real estate. We are neutral due to current valuations, which are compelling.

Office outlook: negative
The success of office REITs are correlated with job growth and corporate expansion, which has been non-existent in 2008. Many companies are not taking new space as they wait to see what happens with the economy.  

Healthcare outlook: positive
Also one of the best-performing sectors in 2008. This is still one of our favorite sectors going into 2009. Healthcare is possibly the most "recession proof" REIT sector; healthcare spending will continue to outpace inflation.

Commercial Mortgage outlook: negative
Commercial mortgage companies make up the worst-performing REIT sector in 2008.  The mortgage REIT business model is broken, and companies are struggling to find viable financing options with the shutdown in securitization. Yields are attractive and probably unsustainable.

Opportunities

We would overweight apartments, healthcare and select retail. A few names we like:

Equity Residential (EQR) - The largest apartment REIT has a geographically diverse portfolio, strong balance sheet and plenty of liquidity.

HCP, Inc. (HCP) - This healthcare REIT has a diverse healthcare portfolio in good long-term markets. The company is moving toward more private pay sources and has taken care of most of its2009 expirations.

Regency Centers (REG) - A well-placed, class-A strip REIT with grocery-anchored centers that should fare better in the economic downturn.  Shares are now available at a heavily discounted price.  

Weaknesses

We would underweight office and residential developers. A couple of names we do not like:

Mack-Cali (CLI) - An office REIT with holdings in suburban markets concentrated in New Jersey. The company’s major geographic markets are weakening due to job losses; occupancy and rent growth will suffer.

St. Joe (JOE) - A residential developer in Northwest Florida. Sales and profits have fallen dramatically in 2008, as builders scale back on projects in this overheated market.

Read the full analyst report on CLI

Read the full analyst report on JOE

Read the full analyst report on REG

Read the full analyst report on HCP

Read the full analyst report on EQR