REITs Attract Yield-Hungry Investors

(page 3 of 3)

REITs that primarily own apartment buildings are in a stronger position than those that concentrate on office, retail, and industrial properties. With home prices continuing to fall, and access to credit diminished, renting is the only option for many people who can't get mortgage loans or aren't willing to buy a house now. Occupancy rates for apartment buildings are currently running at 92 percent to 94 percent, compared with about 88 percent for warehouses and other industrial properties and 84 percent for office buildings, says Rodgers.

Retail properties may be the second-most-attractive asset class. Investors need to be cautious because data show lower retail sales and certain retailers are closing some stores, says Stan Ross, chairman of the board at the University of Southern California's Lusk Center for Real Estate. Office buildings would be his last choice, due to high vacancy rates and a weak job recovery forecast. "The only good news there is that no construction is going on," he says.

banks shunning commercial liquidation

Credit Sights said it finds the biggest challenges in industrial properties because tenants are reluctant to commit to space and prefer to use just-in-time leasing strategies and unconventional inventory management—which is expensive and likely unsustainable.

The fact that the commercial real estate market hasn't crashed as expected is positive, but it also explains the scarcity of acquisition opportunities, which has limited REITs' ability to grow as the economy recovers, says Adornato. Banks and special servicers of commercial mortgage-backed securities have been too willing to extend maturities and pretend that property values haven't fallen because they're reluctant to liquidate properties at distressed prices and they don't want the market to discover the true value of their loans portfolios, he says.

Another reason acquisitions have been slow is that REITs are being outbid for properties in the top markets by private equity real estate funds, which have to invest their clients' money and are often willing to overpay for assets, says Brad Case, an economist at NAREIT.

Certainly, some REITs continue to buy attractive properties. Equity Residential (EQR), SL Green (SLG), and Simon Property Group have been the biggest acquirers so far, according to Credit Sights. Brandywine Realty Trust (BDN) is buying office buildings in downtown Philadelphia and Kilroy Realty (KRC) is acquiring properties on the West Coast, while Boston Properties recently bought a vacant office tower at 510 Madison Avenue in Manhattan.

REITs pursuing distressed properties

First Potomac Realty Trust (FPO) has acquired $121 million in assets in and around Washington over the past year and has changed its focus from flexible space properties to multistory office buildings in the greater Washington market, where it expects lots of assets to be up for sale in the next couple of years. With $100 million of untapped capacity on its credit line and the ability to issue 5.2 million shares of equity, as well as a "proven ability to source off-market deals, and a stated desire to double the size of its portfolio, the REIT's external growth should be more than competitive with its peers over the next few years," Janney Capital Markets said in an Aug. 2 research note.

Real estate firms will have to be creative if they want to continue growing at a time when so many properties are tied up in securitized loans on which lenders are reluctant to foreclose, says Rodgers. With lenders and other holders of commercial real estate debt reluctant to negotiate, REITs are increasingly trying to do deals with equity investors in distressed properties.

BMO's Adornato advises individual investors to make sure that a REIT is flexible enough to be able to make money whether the economy is slow or growing. "If you can't find good properties to buy, you have to make hay with your existing portfolio, either by re-tenanting or redeveloping [space], or if you have the good fortune to be in a sector that's strong even in this weaker economy, like multi-family or self-storage," he says.

Bogoslaw is a reporter for Bloomberg Businessweek's Finance channel.

Business Exchange

Track and share business topics across the Web.