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Author: Reitnut Big red star, 1000 posts Top Favorite Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76759  
Subject: Revenge of the Little Guy (Part 1) Date: 6/1/2008 9:12 PM
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Warning: Excessively long post ahead...proceed at your own risk!

Five months of this rather tumultuous year have elapsed, and so I thought I’d look at the relative performance of our REIT stocks on the off-hand chance that something might be learned.

The data included in the following discussion is based upon my own records, which includes most of the mid-sized and larger REITs. For perspective, so far this year the RMZ (excluding dividends) is up 6.5%. I have been unable to get NAREIT data, as the site is now in transition to www.reit.com. So, here are the average price-only returns by sector, per my data (which excludes some REITs). They are NOT weighted by market cap.

Apartments: +15.3%
Office: +6.1%
Industrial: +2.4%
Retail: Strip Centers: +2.9%
Retail: Malls: +3.9%
Healthcare: +6.0%
Lodging: -3.7%
Self-Storage: +25.1%
Manufactured Home Communities: +2.0%
Net Lease: +3.9%
Commercial Mortgage REITs: -10.2%

Macro IssuesThe champs, thus far, are the storage REITs. Their operating income has held up well, despite the recession (or near-recession), and their cap rates seem to be stickier than in other sectors. Supply of new product has been modest. And, this small sector has been mightily helped by the surprisingly strong rebound at U-Store-It. Apartments are also doing well; while SS NOI growth is slowing, these REITs are still turning in good numbers, as the bust in the housing market is creating enough new tenants to offset the pressure from vacant homes being tossed onto certain markets by busted condo converters and speculators.

Comm’l lending REITs have been the weak sisters, as the credit markets have been routed, causing uncertainty about the repayment of commercial real estate debt when it comes due. Also, leverage is as popular today as a pit bull at a cat show, and these M-REITs use lots of it. The high yields provided by these stocks are seen as merely the by-product of such high leverage, and are not attracting yield-hogs. The performance of the other sectors is close to the mean for the entire REIT industry, so no inferences can be drawn (at least not by me). However, the relative poor performance of the pure industrial REITs is a bit surprising, as industrial space markets have been holding up reasonably well, and AMB and PLD are doing fine overseas. They did, however, score big last year, so perhaps they are just reverting to the mean.

Now, to individual REIT stock performance… About the only theme I’ve been able to come up with is that the smaller guys, in most sectors, are kicking sand in the face of their larger brothers. It’s not quite a “Revenge of the Nerds” type of story, as some of the smaller REITs that are out-performing are well-managed, and hardly of the nerdy type. Let’s take a look.

Apartments: At the top of the apartment heap is a REIT that doesn’t garner lots of headlines, but quietly is doing a fine job of creating value for its shareholders. This is Mid-American (MAA), scoring a smashing price-only return (YTD) of 30.9%. They don’t do much in the way of development, so investors don’t have that issue to worry about. However, they are refurbishing many of their properties, and getting very good returns on their investment. And, of course, it helps that they don’t have a lot of exposure to markets that have been hammered with an excess supply of homes and condos. I bought shares in MAA, beginning late last year, and have been impressed by the management team.

Two other smaller apartment REITs have also performed very well this year, including UDR (+24.6%) and AEC (+24.2%), followed closely by ESS (+22.5%). The common theme here are markets that are very stable and, in the case of ESS, surprisingly strong. The three apartment cellar-dwellers are Colonial (+6.3%), Camden (+2.3%) and Post (+1.1%). These have probably performed relatively poorly for different reasons. I would be speculating about CLP, as I don’t follow the company, Camden has the most exposure to the weak housing markets, and Post has been hurt by the rapidly-diminishing chances for being bought out.

Finally, a quick note on AVB. This is my favorite REIT and I am disappointed by its performance thus far (+7.5%, and below the apartment average). They are doing just fine, and believe that AVB will be an out-performer for the balance of the year – especially as the have the lowest leverage ratio among their peers (under 30%).

Office. This sector has performed in line with the REIT averages. The two best performers are not blue chips BXP or SLG, but rather red-chips LRY and HIW, up 23.2% and 22.5%, respectively. These Rodney Dangerfields are, indeed, getting respect this year, although I can find no specific catalyst for it. My guess is that, not having a major presence in markets that are apt to suffer from a downsizing in the financial services sector, nor in many busted housing markets, they are getting more respect from worry-prone investors who are not willing to pay low implied cap rates for the shares of their more well-known brothers in major high-barrier markets. All that said, BXP, VNO and SLG are running in the middle of the pack, turning in respectable YTD performances.

The weak guys shouldn’t be surprising to anyone. They are MPG, down a whopping 46.7%, and KRC, off 0.8%. The Maguire woes are well known (I have posted on them last week), and perhaps the denouement was the elimination of their common stock dividend. Kilroy is in good financial shape, with modest leverage, but its presence in Southern California markets is causing worries about occupancy and rental rates. Given the sour taste in some investors’ mouths due to its history of providing very generous executive compensation programs, investors aren’t inclined to cut Kilroy any slack.

Industrial: Blame the underperformance of this sector on reversion to the mean, as most of these industrial REITs are doing OK. The two leaders are, consistent with the “little guy wins” theme this year, are EastGroup (EGP) and PS Business Parks (PSB), which are up 13.6% and 9.4%, respectively. I don’t follow either company closely, so I cannot provide even any quasi-insights; I think EGP is big in Texas, which is a good state to be in, given the strength in the oil patch. Also, in the larger equities market, the small caps are doing better than the mid-caps, which in turn are doing better than the large caps. So, perhaps there’s some kind of symmetry at work here.

The poorest performers in this space are FR and PLD, down 9.5% and 2.3%, disrespectively. You all know my thoughts on FR (shoot that turkey!), but I cannot explain the poor performance at PLD – perhaps investors are worried about a US recession dragging down commercial real estate markets in Europe and Asia, thus impacting the prospects for Pro Logis, aka the Development Machine.

Retail – Strip Centers: This sector’s performance is about 350 bps below the REIT averages, due no doubt to the existing and perceived troubles in US Retail (for reasons I need not repeat here). Weingarten is the top dog this year, up 9.7%, while large blue-chip Kimco has been bucking the “small is beautiful” trend by rising 8.1%. I have no idea why WRI is performing so well; they have been expanding their development pipeline rapidly in an environment where the risks have been increasing. I really like the management of this venerable retail REIT, so perhaps they have become the “comfort food” in this sector. KIM is doing relatively well, probably because (a) the stock performed poorly last year, and (b) they have all those projects and investments in Canada, Mexico and Latin America, and a large flow of management fee income.

The bottom two performers here are also something of a riddle to me. Acadia (AKR) is down 3.4%, while Federal is off 1.9%. Both are excellent companies. AKR performed very well last year, so perhaps it’s another reversion to the mean thing. I don’t follow this company closely, so maybe I’ve missed a foul-up by management (but, given the quality of management, I doubt it). Federal has the highest quality assets in this space, but they are encountering a few temporary occupancy problems, while SS NOI, which has been stupendous, has now become only pretty good. Given its assets, it trades at a high PE, and investors may not be willing to accept low implied cap rates in this difficult environment.

Retail – Malls: Up almost 4% YTD, this sector has been holding up reasonably well despite the “death of the US consumer.” Credit this to the malls’ huge embedded NOI as old leases, signed at lower rates, are renewed at higher rates, as well as today’s very high occupancy rates – they will decline a bit, but still be at healthy levels, assuming no economic Armageddon.

The two best performers make an odd couple: The gorilla, Simon, is up 14.4%, while feisty CBL is close, +10.0%. Simon is benefiting from its market power, as well as its secret weapon – it’s Chelsea Premium Outlets. These outlet centers are performing exceedingly well these days, thanks to bargain-hunting consumers and foreign travelers spending themselves silly on cheap dollars. CBL, although owning middling-quality assets which may be less in demand by worried retailers, is fortunate in not having exposure to broken housing markets. Perhaps its 8.3% yield is also helping (yield-hogs may still be alive out there).

The weakest performers include Glimcher (GRT), down 9.4%, while PEI is off 9.5%. PEI has a big development pipeline, which is no doubt scaring the bejeepers out of investors – particularly given the lackluster (at best) past performance of this REIT. And Glimcher is – well, it’s just being Glimcher. So these two nerds have yet to obtain their revenge.

Healthcare: This sector is holding up well in these difficult economic times, although they are just matching the performance of REITs in general. Little LTC Properties (LTC) is, consistent with our theme, beating up the opposition, rising 11.0% this year. Perhaps its low leverage is attracting investors with sweaty palms, and the expectation may be that it will be able to use its low leverage to snag bargains as other levered players leave the sector.

Second-best performer was NHP, which is up 8.8%. Investors must like the value in this stock, as well as the job that Doug Pasquale is doing. Their large new investment in quality MOBs is impressive; while it won’t deliver spectacular FFO growth over the near term, it does help to diversify NHP’s cash flows, and provides more presence in a very stable sub-sector.

Surprisingly to some, HCP is the laggard, down 1.5%. This remains a quality organization, but it is large (a negative this year), and it has more debt leverage than its peers (another negative). While the debt issues are being addressed, investors have no tolerance for it. Investors may also be wondering about whether HCP’s aggressive investment strategy is a mite too aggressive for the current environment. I suspect that the stock will perform better over the balance of the year.

Well, this post is already much too long, and I am running out of time. So, I will continue with a “part 2” in a few days, in which I’ll try to tackle the remaining sectors, should anyone still be around to care.

Ralph
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