Investors bet that good times are ahead for REITs

Even though times are tough for many commercial landlords as rents and occupancy continue to decline, the stocks of real estate investment trusts have surged lately as investors bet that good times are ahead for the industry.

REIT stocks outperformed the S&P 500 by nearly double in the first quarter and doubled their value compared with the same period a year earlier, according to the National Assn. of Real Estate Investment Trusts.

Shares of Los Angeles office REIT Maguire Properties Inc., for example, jumped nearly 300% during the quarter from the year-earlier period but are still trading at a fraction of their peak price in 2007. Shares of Macerich Co., a REIT based in Santa Monica that owns shopping centers, leaped from $5.80 to $38.31 in the same period.

A REIT allows individual investors to participate in large real estate ventures, such as building or buying high-rise office buildings. Unlike other public companies, REITs must distribute 90% of their income to shareholders.

REITs were nobody’s darling a year ago, with the real estate market in freefall and many REITs — including Maguire — overleveraged from borrowing money to buy properties when the market was hot.

“They didn’t look attractive,” said Michael Gillmore, head of real estate in the West at consulting firm Ernst & Young. “They had too much debt coming due.”

Maguire was among the offenders, with loans valued at $260 million maturing in 2009 and billions of dollars more on the books. By the end of the fourth quarter of last year, Maguire had cut its total debt to $3.4 billion from $5 billion at the end of 2007.

REITs also bought trouble for themselves by taking on more debt to pay the level of dividends investors had become accustomed to, an Ernst & Young report said. Shareholders’ expectations were not sustainable, and some REITs experienced “creeping leverage” as they paid more dividends than their earnings justified.

The nadir for REITs was in March 2009. Soon after, REITs raised billions of dollars in capital, often through unsecured bonds. By reducing their debt and recapitalizing their balance sheets, many REITs looked poised for growth.

Commercial real estate sales have been nearly stalled for more than a year, but investors recall the mass liquidation of commercial real estate at bargain prices in the recession of the early 1990s and hope REITs will have the opportunity to take advantage of a similar occurrence soon, said analyst Craig Leupold, president of Green Street Advisors.

So while office buildings and other commercial buildings face more financial challenges in the months ahead, job growth suggests that their outlook will improve as growing businesses rent more space.

“The public market is forward-looking,” Leupold said. “2010 will still be tough year-over-year, but the stage is set for a healthy 2011.”

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