REIT performace during the prospective downturn

[SDbear]

Any ideas on how REITs would perform during the expected housing downturn. Apart from increased valuation due to psychological factors of investors I suspect that REITs are not exposed to the malaise of the recent runup in the real-estate values. According to my understanding REITs own apartment/commercial complexes and office buildings and rely on rent for their income. The only drawback I see is that they might have more debt servicing costs with higher interest rates. Or am I missing something here?

[powayseller]

You’ll get some comments from people who know more than me, but I’d like to add this:
When housing crashes, it’s the value of the land that is going down. That is the speculative component. Construction costs might pull back a little bit as demand eases, but the land will take a hit.

Thus, no matter what the land holds, that property will take a hit too. Apartments, houses, vacant land, commercial and industrial sites will all be worth less because the land underneath is worth less.

A second factor: Lender money will tighten, as foreclosures take down many banks, and others get scared to lend too much. This makes it harder for anyone to get a commercial loan, affecting that market too.

Third, from your comments it’s not clear if REIT properties are overvalued or not. You said “Apart from increased valuation due to psychological factors…” It sounds like REIT holdings did experience a bubble run-up; they are overvalued. Then you say “REITs are not exposed to the malaise of the recent runup in the real-estate values.” This is a contradiction of the first phrase.

Last, are you positive they are cash-flow positive on the rents?

Don’t REITs follow the direction of the residential RE market, or are they subject to different forces?

[Anonymous]

REIT’s are not immune to real estate slowdowns at all, as the core of the business is at stake when these things happen. What will happen is that they will cut back their dividends which is what they use to entice shareholders into their camp. Generally they do not get much volatility in their stock prices, as compared to other stocks. As a result, they use a high dividend to get investors put their money with them.

I had some dealings with Arden Realty a big local REIT in the 90’s during the slowdown and they felt some pain just like everyone else did.

[powayseller]

I just finished reading a REIT forecast, and as they went through each sector: hotel, retail, commercial, rental, industrial, I realized that a recession is going to sock it to all the sectors. For example, they attributed high demand of financial services companies to the high demand for commercial buildings; as mortgage brokers, title companies, escrow companies, lay off thousands of workers, that office will sit empty. Of course, the report painted a rosy forecast for REITs. But then, who ever gives a gloomy forecast for anything economic?

[SDbear]

When I said valuations I meant stocks of REIT might have had a run up due to speculation. When I said they are not exposed to the malaise, I meant they might be less leveraged than individual home owner.

Powayseller,
You are right when you said that their occupancy rates would decrease heavily if economy grinds to a halt. But I’m not so bearish on the economy.
Chris,
You gave a good insight on the local REIT performance during the last downturn.

I was looking at their performance nationally. May be performance of the MSCI REIT Index. I was wondering if anyone has researched on their financial state.

Powayseller,
I would appreciate it if you would give us a summary of the report you read.

I was looking at the Vangaurd REIT index fund. But it’s inception was in 1996. So I could’nt figure out how the fund performed during the last downturn. I could’nt get the index performance during the downturn too. All I found was that the index had an annualized return of 15.40% in the past 10yrs.

If they do not go down in value too much and have decent yield, I could have some exposure to it. An annualised 10% return is still a very good option.
Thanks in advance.

[powayseller]

Dividend Capital Market Cycle Forecast. This forecast is rosy, but gives you the factors which drive REIT performance. For example, if they expect financial services companies to keep hiring because the mortgage industry is strong, they’ll see high demand for their office buildings. I don’t buy into their premises. It’s their job to be a RE bull. Never trust the advice of an economist or expert who benefits from his own forecast.

sdbear, why do you think the economy can keep growing when housing, which has been the main driver of the economy slows? Furthermore, how long can China keep propping up the dollar? Why is it that despite decades-low mortgage rates, low inflation, strong job growth, the US savings rate is negative; how will the glut of baby boomers fund their retirements? If they could save, they would. They’re counting on sales of their homes to be their retirement. Our economy is strong only as long as housing is strong.

[privatebanker]

REITs have been traditionally attractive because of their dividend yields and their low correlation to other asset classes. With the recent run up in this sector, it has created an interesting scenario. The yields on a lot of the REITs have been squashed because the share price has been charging up. As of today, most money market funds are providing an essentially “risk free” yield of 4% – 5% depending on share class. That’s about a spread of 1%+ over the Cohen & Steers REIT index. If you been in the REIT game for a long time, you’d probably know what’s in store. Most major REITs are concentrated in commercial properties. Commercial properties have been red hot the last few years and have been appreciating at record levels just like the residential market. I think we all know where residential properties are going. Why would commercial properties be so different? Sure these big companies have a lot of cash but at some point the cost of borrowing will become too expensive and pull down the property prices. Basic supply and demand.

I’ve gotten out of REITs entirely. The risk is too high now. If you’re more strategic than tactical, I’m sure they will revert to their average return over the long haul. There just may be some big pot holes in the road in the near term.

[Author]

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