From a small northwestern observatory…

Finance and economics generally focused on real estate

Posts Tagged ‘NAREIT

Corporate Investment — Much ado about…. something

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I can’t believe it’s been a month since I posted — I’ve been traveling almost constantly the past few weeks, and between that and the elections, my dance card has been fairly full.

The trigger for day’s post was an article in the Wall Street Journal on Monday, “Investment Falls off a Cliff”, with obvious homage to the impending fiscal cliff.  I don’t want to minimize the danger of the “FC”, and in fact all bets are really off if the worst case scenarios come to pass.  Here at Greenfield, we don’t really believe Congress and the White House will both fail to blink.  Nonetheless, “keeping your powder dry” is always good advise in perilous times.

I’d like to comment on two things, though.  First, while direction of corporate investment isn’t good, it’s not quite “double dipping” just yet.  Indeed, one might argue that the current downswing in investment is nothing more than seasonal backing-and-filling.

courtesy, Wall Street Journal

Note that after coming out of the recession, overall investment spending took a brief respite in early 2011, as well.  Of course, equipment and software appear to continue healthy, but structures are dragging the overall index down.  Part of this can be explained by the relaxation of the apartment construction surge that we saw over the past several quarters.  Many analysts now believe the demand-overhand in apartments is close to saturation (or at least satisfaction) and this sort of slow-down is neither unusual nor unhealthy.  Note that the NFIB optimism survey is still trending upward, although the Business Roundtable CEO survey (which surveys heads of larger firms than the NFIB does) had turned downward.  I suspect that’s a rebound effect — small businesses are still clawing their way out of the recession, and are less affected by what may happen if the FC becomes reality.  The larger firms were the first to enjoy the fruits of the recovery, and would be the worst hurt by tax increases and the FC cutbacks (particularly in defense).  Nonetheless, both of these sentiment measures are well off their 2009 bottoms.  Consumer sentiment, which ultimately drives much of this, is as good as its been since before the recession.

Second, I’m concerned about the negativity spreading to real estate.  Note that real estate investment comes in three flavors — development, capital gains, and income.  The downturn in investment has SOMEWHAT negative implications for the first.  Real estate developers will have to be more careful in a slow-down environment, but that’s been true throughout this recovery.  Financing is difficult, even in the “hot” apartment market, and so admittedly the commercial real estate developers may be in for a tough run.  (Residential development, on the other hand, is rebounding nicely.)  Capital gains is a “long game” anyway.  Certainly the tax changes which seem inevitable in 2013 and beyond have negative implications for the buy-and-sell crowd, but the returns to those who can hold thru cyclical downturns have always been healthy even after tax considerations.

Real estate income (primarily REITs) may actually be benefitted by a slight retrenchment in development.  If and as the economy continues to rebound, offices, warehouses, and shopping malls continue to fill up.  Lack of new supply (from a cyclical downturn in development) benefits the sort of existing structures which are typically part of a REIT portfolio.  As always, investors will be benefitted from looking at good managers with top-drawer properties and a history of increasing FFO.

Written by johnkilpatrick

November 21, 2012 at 10:35 am

Economic outlook — fundamentals and shocks

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I love boating, I really do.  To quote from Grahame’s famous The Wind in the Willow, “…there is NOTHING–absolute nothing–half so much worth doing as simply messing about in boats.”  However, any experienced sailor has had one of those days when the water was perfect, the wind was with you, but off on the horizon a storm cloud lurked.  “Will it head our way, or pass us by?” is the key to whether the fun cruise continues or not.

Today, and for the next few weeks, the economy is like that.  The wind is definitely at our backs, and things are generally looking up.  That having been said, the fiscal cliff continues to loom on the not-too-distant horizon.

First, the good news, and there’s plenty of it.  I’m on the Board of an investment fund (and in fact just got named chairman of the board this month, for a two-year stint).  We had a great briefing yesterday from our lead fund manager, and macroeconomic news was as good as I’ve seen it in a while.  Corporate profits are at near-record levels as a percentage of GDP, and non-financial interest expense as a percentage of profits is at a near-record low.  Lending is back up, although corporate lending isn’t quite as robust as consumer lending,  and current stock market price-earnings ratios (measured on a 12-month trailing basis) are at levels usually associated with strong intermediate-term (5-year) market returns.  Equity risk premia tell the same story.

On the real estate side, everyone’s seen the news that the S&P Case Shiller index is trending back up, and this morning’s news report puts current housing starts above an 800,000 annualized level (note that we’re hoping for a million, and at the trough of the recession we were at a record low 300,000-ish).  Manufacturing has added about a half-million jobs since the trough of the recession (early 2010), and is about 300,000 above where it stood in July, 2009.

The implications for real estate investment are clear, and as I reported earlier this week, the total return on U.S. REITs has exceeded 30% in the past year, besting the S&P 500.

With that in mind, though, the fiscal cliff continues to trouble us all.  If you’re not familiar, on January 1, the Bush Tax Cuts will expire and mandated federal spending cuts are scheduled.  Together, these two will hit the economy to the tune of about 4% of GDP (yes, driving us into a second recession).  Sadly, the solution is political, and this is all coming at a time when Congress and the White House are totally focused on the impending election.

We’ll keep you posted, and we’re preparing some private white papers on this subject for our clients as the season moves forward.

Written by johnkilpatrick

October 17, 2012 at 8:51 am

REITs — good news trumps “iffy” news

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The “headline” in Erika Morphy’s piece in GlobeSt.Com this morning was that was that REITs underperformed the S&P 500 for August and September.  Specifically, REITs were up 1.85% in the 3rd quarter this year, compared to 6.35% for the S&P 500.  You have to dig a little deeper to get to the heart of the matter, though.

First, let’s remember that investors by-and-large buy REITs as an income vehicle with equity up-side.  The current average REIT yield is 3.88% — not bad, compared to corporate bonds or preferred stocks, and more targeted income seekers can go after single tenant retail with a yield of 5.9%.  (For a great review of this, see a piece by Brad Thomas in Forbes.com from September 10).  Couple those sorts of dividend yields with any upside equity potential, and you have a real investment powerhouse in today’s market.  For comparison, the current yield on the S&P 500 is 1.97%.

But, the news gets better.  For the 12-months ending September 30, the NAREIT index was up 33.81%, compared to 30.2% for the S&P.  Do the math — the total return for a portfolio of REIT shares for the past year would have been (33.81% + 3.88% = ) 37.69%.  The total yield for the S&P 500 would have been (30.2% + 1.97% = ) 32.17%.  Thus, slightly more than a 500 basis point return advantage to REITs.

Of course, (and this goes without saying), past performance doesn’t translate into future returns…..

Written by johnkilpatrick

October 15, 2012 at 9:46 am

Rays of sunshine

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Fall isn’t usually the time we talk about rays of sunshine, particularly not here in Seattle where we all “hunker down” this time of year for the long, dark, wet winter.  Plus, I just came back from three weeks on the road (nine hotels, 4 time zones, two rental cars with a combined 2,000 miles, and four plane flights).  One of the first things to hit my in-box was the periodic Real Estate Investment SmartBrief from the National Association of Real Estate Investment Trusts with the headline “Hopes for U.S. Rebound Fade as Global Trade Slips”.  Sigh….. not a really nice headline, eh?

Now, I have the greatest respect for NAREIT, and out of fairness, they lifted this story from the Wall Street Journal.  Nonetheless, when the market opened this morning, it actually darted into positive territory, with the S&P hovering above 1450 as I write this.  (I hope I don’t jinx it!).  Of course, the stock market has risen for the past three Octobers, and in fact the market had a significant rally in September — a rarity for a month that’s usually fairly flat — with the S&P gaining almost 3% and the Dow picking up about 2% during the month.  The “rally” this morning was triggered by two things.  First, the ISM report (Institute for Supply Management) came out in positive territory for the first time in four months, confounding analysts who thought it was continuing downward.  Second, this caused the short-sellers, who have banking on a negative October, to re-think their positions.  Hence, the really great bounce this morning was, in no small part, a lot of short-covering.

No question about it — a shrinkage in global trade is an unsettling thing, for three big reasons.  First, it signals that the net importer regions (particularly Europe) are continuing in the doldrums.  Second, healthy economies which are heavily trade based (such as the U.S.) depend on trade to stimulate GDP growth.  Finally, China is the world’s biggest manufacturing floor right now, and depends on trade to provide full-employment — nothing frightens Chinese officials more than unhappy workers with no jobs.  Thus, from both an economic perspective as well as a geopolitical perspective, a shrinkage in trade — or even a shrinkage in the growth of trade — is a bad thing.

Notably, also, while manufacturing is only 20% of the U.S. economy, it is 40% of the profits of the S&P 500.  Pundits are already noting that the ISM report is just one data point, but it’s a very important one.  In the next few days, we’ll see if the good news from ISM is sustained by other sectors of the economy.

 

 

Written by johnkilpatrick

October 1, 2012 at 9:10 am

REIT Research — Real Estate in Volatile Times

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The National Association of Real Estate Investment Trusts (NAREIT) recently commissioned Morningstar to study the role of securitized real estate in the well-balanced portfolio, with a particular eye to the investor attitudes regarding risk, as well as the actual performance of markets.  Both of these two concepts — risk and investor attitudes — are less well understood than researchers seem to think.  In the first, market models assume a degree of normalcy in the distribution of market returns.  However, empirical evidence seems to contradict this, and in fact market volatility is significantly greater (and of greater magnitude) than models would predict.

In the second case — investor attitudes — traditional models suggest that rational investors react to “up” markets in the same way as “down” markets.  More recent behavioral models recognize the fallacy in this — rational investors relish “up” volatility, but loathe down markets.

The results of the research were published in an excellent new research piece from NAREIT titled “The Role of Real Estate in Weathering the Storm” (click on the title for a copy of the paper).  Some high-points from the study:

  • Since 1929, the S&P 500 has had 10 months with declines of 15.74% or more — which is eight more than would be predicted by a normal distribution.
  • Recent studies by James Xiong of Ibbotson Research show that the log-normal distribution fails to account for this down-side volatility.
  • From 2000 – 2009 (often called the “lost decade”), the cumulative return on large-cap stocks was negative 0.95%.

Morningstar then crafted portfolios under the “theoretical” model (normal distribution) versus a more realistic model of volatility, with alternative structures for risk-averse investors and more risk-tolerant investors.  Investment returns were measured over the period 1990 – 2009, which notably included the recent market melt-down.

Under normal distribution assumptions, an optimum risk-averse portfolio would allocate about 6% to securitized real estate and theoretically enjoy a return of 7.6%.  Under more realistic volatility assumptions, the risk-averse portfolio would allocate 14% to securitized real estate and would have returned 8.2%.

A more risk-tolerant investor would have allocated 18% to 20% in securitized real estate, and would have enjoyed a return of 9.7%, with volatility (standard deviation of portfolio returns) of 10%.

The most striking finding of the study was the consistent role played by securitized real estate in all four of the models (normal versus non-normal, risk-averse versus risk-tolerant) and particularly thru the market melt-down.  While this may seem counter-intuitive, given the roller-coaster ride of REIT prices, investors need to realize that REIT shares paid relatively high dividends through this period, thus ameliorating the downward price movements.  In short, the gains from real estate holdings pre-meltdown, coupled with the dividends, more than made up for the price bounce over the past few years.  Further, REIT prices have rebounded better post-recession than have other S&P shares.

Written by johnkilpatrick

September 12, 2012 at 4:56 am

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