REITs Still Appealing in Midst of Slowdown

Stocks of real estate investment trusts will be a relatively safe haven for investors for the rest of this year despite slackening demand for office and industrial space and the effect of dot-com failures on the real estate industry, a number of analysts say.

REIT shares are outperforming the broader market thus far this year, as they did last year, though analysts say the downturn in the real estate industry is bound to eventually affect REITs.

Still, many experts say the effect of the economic slowdown will be moderate on REIT companies’ finances, which means the appeal of these high-dividend stocks is unlikely to be dimmed much.

“If the economy stays soft, we think REITs will do well on a relative basis,” said analyst Ross Smotrich of Bear, Stearns & Co. in New York. “The real estate markets, even though they are not as strong as a year ago, are still relatively healthy.”

Even the best real estate markets will be affected by an economic downturn, Smotrich said, but “I don’t think they will be hurt terribly badly.”

A Bloomberg News index of 146 REIT stocks has gained 2.7% this year, while the blue-chip Standard & Poor’s 500 index is down 3.2% and the Nasdaq composite index is down 8.9%.

With the annualized dividend yield of the average REIT about 7%--compared with 1.2% for the average blue-chip--the “total return” on REIT stocks (dividend plus price gain) averages about 5% so far this year, according to a Morgan Stanley index.

In the wake of the stock market’s plunge over the last year, dividend income has gained fresh appeal with many investors, bolstering demand for REIT stocks.

But Smotrich points out that it’s important for investors to differentiate between different kinds of REITs, some of which will do better in a slowing economy than others.

REIT dividends, after all, are dependent on the rents the companies earn on the properties they own, and what they earn when they sell properties.

Apartment and industrial REITs are relatively strong bets in a slowing economy, Smotrich said, because both types of properties tend to weather economic slowdowns better than offices or some other property classes. Apartment and industrial REITs usually own properties over a broad geographic area, offering protection against a sharp downturn in any one local market, Smotrich said.

Apartments also do well in a slowdown because home buying slackens and people stay in apartments longer, Smotrich said, while industrial properties benefit from some of the choices that corporate managers make in a slowdown.

“Industrial space is more likely to be mission-critical for a lot of companies,” Smotrich said. “A company with expensive office space as well as inexpensive warehouse space is more likely to vacate the office space and keep the warehouse space because it needs it for its inventory.”

West Coast office REITs can still do well in a slowing economy, according to analyst Craig Silvers of Tucker Anthony Sutro in Los Angeles.

“We believe the West Coast will remain undersupplied and will remain, long-term, a high-demand market,” Silvers said. “What’s happening right now with the tech meltdown is just a phase that will be worked through.” After a slow period of flat or declining rents, rental rates will begin to rise, beginning possibly late this year or early next year, Silvers said.

He is less sanguine about hotel REITs and owners of shopping malls, and he cautions against REITs that have built too much new space in recent years without first lining up tenants.

Current conditions have prompted many investors to ask if real estate markets are going to tumble as they did in the early 1990s, said Jeff Furber, managing partner of Boston-based AEW Capital Management.

“The answer is clearly no,” said Furber, whose firm recently issued a report saying that, “in any but the most severe economic scenarios, real estate generally and REITs specifically will continue to outperform most sectors of the broader equity market over the next 12 to 18 months.”

AEW doesn’t expect REITs to produce the same explosive returns as in 2000, when the Morgan Stanley total-return REIT index soared 27%, and the average REIT stock mutual fund surged 26.2%, as investors fled more speculative stocks for safer securities.

Even so, “we do expect about 10% to 12%” total returns on REIT shares in 2001, Furber said. That would be close to the annual average for the last decade or so, he said, despite the lean years of 1998 and 1999, when investors dumped REITs in favor of other shares.

“The difference now versus a year or two ago is that 10% to 12% is going to be considered a good return” in the stock market, Furber said.

Silvers of Tucker Anthony Sutro predicted that REITs “will continue to get the respect they’ve regained” over the last year or so.

“The consistency of REIT earnings and dividend yields help them stack up very well, perceptually, in the minds of investors today,” Bear Stearns’ Smotrich said.

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Revival Continues

After tumbling in 1998 and 1999, real estate investment trust shares rebounded in 2000 and have continued to inch higher in 2001.

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Bloomberg REIT share index, quarterly closes and latest

Friday: 124.16

Source: Bloomberg News