Retail real estate investment trusts have been thundering along in a bull market for a few months, with average stock prices up over 25 percent year-to-date, thanks to improved operating trends and higher demand. The stock gains were achieved despite investors and industry executives squabbling over valuation metrics.
Meanwhile, one big Wall Street firm said in a research note that valuations in the broader REIT market could continue to see some gains as companies leverage positive economic trends. In short, it’s a good time to be a REIT.
“We believe REITs should deliver more modest returns over the next 12 to 15 months, in the 8 to 12 percent range, based on solid, high-single-digit earnings growth, plus the current 3.8 percent dividend yield and assuming stable multiples,” said Goldman Sachs equity analyst Jonathan Habermann in an industry outlook report. “In our view, REITs should remain appealing to investors given the lower return expectations on the part of institutional investors.”
Habermann said he expects REITs to continue to post improved operating fundamentals as well as ongoing demand in key markets. Regarding mergers and acquisitions activity, which have been partly driving valuations, the analyst sees deals continuing through next year. Until then, REITs can celebrate robust stock gains made so far this year.
Of the 27 public retail REITs tracked by WWD, the unweighted, average gain of the stocks from the first day of trading this year through Nov. 14 was 21.7 percent (see chart). The shares of 25 firms experienced gains while two, Feldman Mall Properties and Mills Corp., showed declines of 10.7 and 52.4 percent, respectively.
Of the stocks that had gains, 20 showed increases of 20 percent or more. The top gainers were Forest City, Saul Centers and Vornado Realty Trust, with increases of 46.5, 46.3 and 42.4 percent, respectively. The bulk of the gainers delivered results more in line with Simon Property Group and Cedar Shopping Centers, which saw increases of around 25 percent.
Regarding the top performance of Forest City, Maria Maslovsky, analyst of real estate finance at Moody’s Investors Service, said Forest City “is a very good company, but the reason they aren’t talked about as much is that it’s family-controlled and they tend to do large-scale, long-term projects. Ten years isn’t long for Forest City.”
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The gains made in retail REITs are below that of the entire REIT sector, but ahead of other indices in the market. The National Association of Real Estate Investment Trusts’ Equity REIT index is up over 36 percent for the past 12 months, while the Dow Jones Industrial Average is up about 15 percent and the S&P 500 is up roughly 16 percent.
The broader, multisector bull market is attributed to several factors, including a decline in fuel costs, improved consumer confidence and low interest rates. From the perspective of running a big business, current market conditions favor borrowing. And even though many stocks are at 52-week highs, including many retail REITs, investors see fair valuations. On top of all this, c-level executives are more confident than ever. These economic conditions are also the reason why M&A activity is so hot right now.
In regard to retail REITs, the sector’s performance in the third quarter was top-notch, and helped boost stock prices higher. Simon Property Group, for example, posted a 27.2 percent gain in third-quarter net income. And since August, the stock is trading up more than 12 percent.
Regency Centers Corp. delivered robust results for the quarter, with same-store net operating income, rental rate and funds from operations all up significantly. Since August, Regency’s stock is up over 10 percent. Other retail REITs did similarly well.
As stock prices soar, industry analysts and company executives have continued their debate over the best way to value a REIT. Some analysts and companies prefer stock value modeling based on NAVs, or net asset value, while others say it’s better to go with the flow of other sectors and create metrics based on earnings.
Richard Moore, managing director of equity research RBC Capital Markets, said REIT stocks are increasingly being treated like issues from other sectors. “In terms of stock investments, the REITs themselves were at the bottom of the pack as a choice except recently,” Moore said. “Now it’s been flipped around.”
Jon Fosheim, chief executive officer and coportfolio manager of Oak Hill REIT Management, said during a panel at NAREIT’s recent annual conference in San Francisco in November that values in the current market are by potential earnings. “But earnings can have a lot of noise in them,” he added. “Not all earnings are the same.”
Whether REITs decide to get on the same accounting page and issue more standardized earnings remains to be seen. Meanwhile, REITs are poised for growth, although the retail sector may decelerate.
“Within real estate, apartments are showing a lot of growth, and office has picked up. Retail doesn’t look as exciting because it’s very Steady Eddie,” Moore said. “In ’06, retail real estate is going to get its butt kicked relative to other property types, but retail earnings haven’t changed.”
In Habermann’s outlook report, the analyst said the valuation gap between publicly traded stocks and the private real estate sector has narrowed. “But there still continues to be strong interest on the part of institutional and foreign investors, as well as private equity capital,” he said in the report.
In a research note last week, Ross Nussbaum, senior equity research analyst at Bank of America, said most REITs he met with at the NAREIT conference “do not believe a recession is likely in 2007. Instead, the commonly held view is that demand will remain steady, or slow slightly from levels seen in 2006.”
Nussbaum said “new supply is being constrained by higher construction costs, but rising rents in many markets will likely cause more developers to pull the trigger in 2007. REITs with development pipelines are, in almost all cases, firing up the construction engines.”