Tuesday, April 14, 2009

Equity Investment Perspectives In The REIT Space

Zero Hedge has voiced its thoughts on the matter repeatedly (to the point where a broken record sounds outright creative) so I will present those of BCA Research instead, as the latter has some notable conclusions on the rationality of equity investments into the REIT sector.
REITs have historically been at the top of the yield-generating heap, but look to be in jeopardy of losing their appeal as reliable cash flow growth vehicles.

At first blush the attractiveness of REITs looks good. The dividend yield on the S&P REITs group is almost as high as at the end of the relative performance bear market in 2000 (Chart 15). Piling into REITs back then would have generated substantial capital gains as well as an attractive running yield in the subsequent years. But the differences between now and then are enormous.

Many REIT operators took advantage of what looked to be a permanent increase in demand and undertook a rapid facility build out. Our construction composite for the primary REIT sectors has been growing far above-trend for several years. If the residential market is any guide, a prolonged building retrenchment will be needed before underlying property prices will stabilize, especially in view of the plunge in occupancy rates.

Chart 16 highlights a number of indicators of demand. BCA’s REIT demand indicator continues to sink, consistent with a drying up in demand for commercial real estate loans (top panel, Chart 16). Vacancy rates have exploded higher in some categories. Our overall vacancy rate indicator, a composite of our REIT demand and supply indicators, shows that the vacancy rate composite is headed much higher (second panel, Chart 16). Property owners will have a very difficult time raising rents to existing tenants given a glut of unfilled space, and the ability to attract new tenants will be limited until overall economic activity improves significantly. The implication is that generating cash flow growth will become increasingly challenging, and some payouts are at risk of getting slashed.

Adding it up, the REIT sector does not offer an attractive opportunity to gain exposure to income. In fact, excess capacity argues for moving up in the corporate capital structure towards bonds. [very critical to note for investors who just threw a ton of money down the follow-on equity offering chutes in several names]. Deflation risks will hurt earnings before balance sheets. Deleveraging also favors credit over stocks. Perhaps investors are already moving in the direction of corporate bonds. Net sales of corporate bond funds have soared. In contrast, net sales of equity funds continue to sag. Retail investors appear to be looking to take advantage of juicy corporate bond yields that are already pricing in a grim financial outcome in most sectors, including REITs and utilities. The same cannot be said for the REIT sector in the equity market (in relative terms).
In a nutshell - if you really want, nay need, REIT exposure, buy bonds, stay away from equity. If recent stock actions by REITs such as KIMCO and ProLogis benefit anyone, it is the bondholders, since they will see benefits long before any incremental cash flows through to equity holders. Yet bonds have not had nearly comparable moves to what these companies' equity prices have demonstrated (30-60% upside moves in 2 weeks): in short, REIT stock are far ahead of the recovery curve, especially since even bondholders don't believe in significant upside value. Then again, if the whole thesis of marginal upside purchasing on declining volume has been true for the broader market in general and the REIT space in particular, once the real money (quants) becomes a participant in the next market move leg, watch out below. As ML pointed out, the quants have missed the upmove, but one can bet they will not do so with the move lower (not if but when it occurs). The only conclusion - once the flip occurs, and the quants jump on board for the reversion, the carnage will be unprecedented.

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Anonymous said...

Like a deer in the head lights.

Anonymous said...

Pursuant to the discussion regarding the "Merrill let loose posting", I think the key bit comes right near the end:

"once the real money (quants) becomes a participant in the next market move leg, watch out below. As ML pointed out, the quants have missed the upmove, but one can bet they will not do so with the move lower (not if but when it occurs). The only conclusion - once the flip occurs, and the quants jump on board for the reversion, the carnage will be unprecedented."

It makes sense to me that, having missed the mega-rally, the HFs have an interest in increased volatility so that in relatively short order they can catch up in terms of relative performance vs. the broader market. Not that they have total control over what's going to happen, or trigger a sell-off, but it sure seems like a bearish bias in the forthcoming volatility is the most likely outcome.

Anonymous said...


I could write a dissertation on why REITs are screwed. The consumer levels are not sustainable for most retail. This will drive the market down, way down.


Speaking of which, as a fellow SRSer before ever reading your blog, I'd love to get your thoughts on the recent action. I'm in at $63, $48 and $35 as well. Interesting times brother. How IYR is not a teenager floors me.

Anonymous said...

"to the point where a broken record sounds outright creative"

Maybe, just maybe your next story will be on HF liquidity and how everyone should be very scared of the big bad liquidity monster cause he's looking to stop you little day traders out cold! Margin calls for 'errbody.

I can't believe you guys got that stock issue pushed out the door today @ $123. LoL

What's your stock trading at now? $115 or something!?? LoL!! Nice. They don't call you Goldenslacks for nothin.

mr. creasote said...

"What's your stock trading at now? $115 or something!?? LoL!! Nice. They don't call you Goldenslacks for nothin."

Kaiser D must have taken a look at his site traffic graphs again tonight.

looking like the eToys chart, pal?

Anonymous said...

uhh, who is BCA Research? I'm in real estate and have never heard of them. doesn't seem like it's really their thing based on those charts....looks more like your typical weak analyst trying to cover a sector they know nothing about. there is really no data in what you quoted, and their "conclusions" are vague at best.

some REIT's are definitely on the way out, just like some companies in every sector are on the way out. but real estate is different from other asset classes (something REIT analysts usually don't understand) - the assets are actually unique and you need to understand that before making any investment judgements.

(by the way, there are most definitely potential bondholders who believe in upside. there were investors looking to buy GGP bonds because they saw value there.)

Anonymous said...


aviat72 said...

Anonymous @ 11:37PM:

BCA is a Canada based independent research firm whose reports are widely respected since they do not have an IB bias. They may be right or they might be wrong; however they do not have any major skin in the game and call it the way they see it. Clients pay them for not for being on one side or the another, but reporting what they see.

As a general rule of thumb, on average CRE cash-flows are going to be between 20-30% less than the peak. 10-15% less occupancy with another 10-20% lower rents. If your position in the capital structure can not take the hit, then exit while there is a chance.

Anonymous said...

I wouldn't short this market for all the gold in India.

If you have noticed the stopping power that greets any downturn you will agree.

I'd stay on the sidelines, because when Goldie-lox takes the training wheels off this mid-800 range we're going to 950-1000. There is too much risk locally and globally that can effect this market.

creasote said...

clicky click --

above comment was intended for Anonymouse @ 11:14 who seems intent on outing ZH as being Goldie-lox in a bear suit.

'twas simply a kind reminder that people with glass blogs should not throw stones lest they wish to have some broken panes themselves.

thus, for now, clues will remain too obtuse for google.

but here's another:
tick tock goes mr. market

if the Kaiser's Broad accusations are correct, then so be it. Tyler can find me on the steppes of Mongolia with a satellite T1 connection and we can have a death match amongst the yurts. he can even blog about here right after...if he wins.

but until proven otherwise, i say ZH=GS accusations are more filled with jealousy than accuracy.

wherever the Kaiser holds his belt.