Real Estate Investment Trusts Poised For Biggest Decline

U.S. Real Estate Investment Trusts are poised for their biggest decline in almost a decade as higher borrowing costs curb takeovers and reduce property values.

After outperforming the Standard & Poor’s 500 index every year from 2000 to 2006, stocks of real estate investment trusts, or REITs, here may drop as much as 20 percent in the next 12 months, according to Kenneth Rosen, an economist at the University of California, Berkeley.

“REITs are overvalued by 25 to 40 percent relative to stocks and bonds” and cash flow yields are too low, said Rosen, who also manages a hedge fund in Berkeley, California, that invests in real estate securities.

Property trusts that own office buildings, apartment complexes, hotels and shopping centers are losing value as banks and investors shun bonds and loans backed by subprime and commercial mortgages. That is going to drive down REIT prices, said Jeffrey Tyler, an American Century Investments fund manager.

Morgan Stanley analysts said last month that REIT returns could decline 10 percent.

The National Association of Realtors, based in Chicago, said last week that sales of previously owned U.S. homes fell more than economists forecast in September as higher mortgage rates made it more difficult for potential buyers to get financing. Sales were down 19 percent from September 2006 and the median home price dropped.

The 128-member Bloomberg REIT index returned 78 percent with dividends in the two years before its Feb. 8 peak, the day before New York-based Blackstone Group bought Equity Office Properties Trust for $23 billion, or $39 billion including debt, in the U.S. real estate industry’s largest leveraged buyout.

Since then, the index has fallen 16.5 percent after dividends as commercial mortgage rates climbed as much as 2 percentage points above the 10-year Treasury note. The last time the REIT index declined more than 10 percent in total return was in 1998 when investors were diverting funds to high-flying Internet stocks.

REITs outside the United States also have declined. The 40-company Tokyo Stock Exchange REIT index, led by Nippon Building Fund and Japan Real Estate Investment, is down 28 percent from its high last May. The 14-member Bloomberg Europe Real Estate index, led by Unibail-Rodamco, is down 33 percent from its February peak.

Warehouse and industrial REITs are the only group in the Bloomberg U.S. index that has not lost value this year, gaining 11.5 percent as U.S. imports of raw materials and consumer products increased. Public storage REITs dropped the most, down 19 percent. Apartment REITs decreased 13 percent and office stocks declined 12 percent. All returns include dividends.

The U.S. office vacancy rate increased to 9.8 percent at the end of September from 9.7 percent in the second quarter, and rents in San Francisco and the New York borough of Manhattan climbed at the slowest pace in more than a year in the third quarter, according to the real estate brokers Studley and Cushman & Wakefield in New York, and Grubb & Ellis in Chicago. “There is plenty more shakeout to go in the REIT market,” Tyler, at American Century, said. “Property values are going to be under pressure, and by extension that will move to REITs.”

Sam Lieber, president of Alpine Mutual Funds in Purchase, New York, sold what he called “lesser-quality” REITs as prices climbed starting in the fourth quarter of 2006. “They got very expensive,” Lieber said, declining to identify specific companies. He expects higher growth from REITs outside the United States.

“International has greater growth and there have been significant currency benefits as well” as the dollar weakened against the euro and other currencies this year, Lieber said.

The Alpine Global Premier Properties Fund, with a market value of about $1.6 billion, has about 28 percent of its assets in the United States, compared with about 40 percent to 45 percent for the majority of similar funds that invest in real estate worldwide, Lieber said.

Lieber bought shares of Unibail-Rodamco, the largest European REIT, after it fell as low as €161.22, or $221, in August, two months after the company was created in June through the merger of Unibail Holding of France with the Dutch shopping-center owner Rodamco Europe. He previously had sold shares of Unibail for a four-fold gain in the period before the takeover.

Economists and Federal Reserve officials are predicting the real estate slump will curb economic growth. Ben Bernanke, the Federal Reserve chairman, said this month that housing “is likely to be a significant drag on growth in the current quarter and through early next year,” although it is too early to assess whether the drop will slow consumer spending and business investment.

U.S. real estate: The REIT stuff goes wrong
By Dan Levy and Hui-yong Yu | Bloomberg News