From a small northwestern observatory…

Finance and economics generally focused on real estate

Posts Tagged ‘REITs

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

REIT Fundraising on the Rise

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According to SNL Financial, U.S. Equity REITs have raised $35.27 Billion through August 10th, over 10% more than was raised during the similar period last year.  Continuing with the debt/equity theme we noted in a recent post, senior debt only constituted about 38% of this total ($13.53 B) with the remainder coming from common equity ($14.72 B) and preferred equity ($7.02 B).

Interestingly enough, Health Care REIT had the largest stock offering at $810.8 million, followed by Kilroy at $230.5 million and Taubman Centers at $281.5.  All three of these are notable, as none of them are in the “hot” apartment sector.  Indeed, of all of the sectors, health care raised the most at $7.7 Billion, followed by retail at $7.61 B.

The bigger question, of course, is what does this say about the real estate market?  REITs buy cash flow, not capital growth, and respond to investor demand for something to take the place of flat-lined bonds.  Given the risk of holding long-term bonds in an up-ticking interest rate market, compared to the yield margin and inflation hedge of REITs, this may be less a commentary on the quality of the property market and more a comment on the demand for REIT shares.

Written by johnkilpatrick

August 21, 2012 at 10:48 am

Real Estate Securities and Stock Markets

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Is securitized real estate a stock, or is it real estate?  It’s a bit of both, but the degree of correlation between securitized real estate (most often “REITs” in the U.S., other forms elsewhere) and the stock market in general has long been a matter of some debate.  In my own work I’ve cited studies that show a high correlation between REIT returns and the S&P 500, but I’ve always been a bit uncomfortable with such gross generalizations.

In the current issue of the Journal of Real Estate Research, Prof. Nafessa Yunis of U. Baltimore does an excellent job exploring this topic, not only in the U.S. market but also nine other countries that have both mature stock exchanges as well as mature securitized real estate markets.  She not only looks at inter-market correlation, but also controls for other macro-variables, including GDP changes and interest rates.

She finds that real estate securities returns are “cointegrated” with both the respective stock market returns as well as key macroeconomic factors, but that the degree of linkage varies among countries.  The greater the degree of market maturity, the greater the cointegration.  In general, shocks to the stock market or to macro-variables impacts the real estate market, but not necessarily the other way around.  Intriguingly, shocks in stock returns, M1, GDP, and CPI have positive impacts on real estate returns, but shocks to long-term interest rates induce negative but temporary responses in real estate returns.

In a way, these findings are both useful and disturbing to portfolio managers.  On one hand, Dr. Yunis’ findings help allay fears that real estate securities are “something else” and difficult to understand.  However, she also notes that there are no diversification gains (she doesn’t use “arbitrage”, but I believe that’s what she means) from holding both real estate and non-real estate securities.

Full disclosure — I’m a reviewer for this journal, although I did not review her paper.  The Journal of Real Estate Research is widely regarded as one of the two top real estate academic journals in the world.  Inclusion in this journal is a mark of distinction for any young author, and it gives significant credence to Dr. Yunis’ findings.

Written by johnkilpatrick

July 19, 2012 at 12:18 pm

REIT Development Pipeline

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On June 28, Fitch Rating Services issued a report on the REIT development pipeline that has generated a bit of discussion in the real estate community.  Fitch’s emphasis was on the lack of development — with some noteworthy exceptions — and how this has “not a meaningful” implication for REIT credit risk.  However, the topic is important from a fundamental perspective, and deserves a bit more discussion.

Historically, REITs weren’t in the development business.  REITs are a tax vehicle, and to maintain that status, they’re supposed to collect rents and pay 95% of those rents out to shareholders (well, that’s a gross oversimplification, but let’s go with it).  As such, REITs enjoy preferential tax status, and have usually enjoyed excellent leverage.  REITs have some significant limitations on the proportion of profits which are supposed to come from business enterprises, capital gains, and such, and can lose their preferential tax status if these other items exceed a certain threshold.

During hot and heavy times (let’s say, pre-2007), REITs are hit with a triple-whammy.  First, they depreciate existing properties, and need that depreciation to shelter income (and thus exceed the 95% threshold, which they usually do and which investors expect).  Second, they were loathe to sell fully depreciated properties in order to buy new ones, because the huge capital gains from sales would impact the preferential tax status.  Finally, developers were demanding large premiums — income producing buildings were selling for amazing multiples which barely made sense (that’s called a “bubble”, folks).

The good news for a REIT was that if they developed their own properties, the development profits could be kept in-house, and there would be no fatal tax recognitions.  Depreciation expenses stayed high, and they could thus pay-out higher and higher funds from operations to shareholders.  It was a win-win.  The only downside, of course, was that development activities were considered risky, and so the credit rating agencies kept a close eye on these practices.  However, REITs were typically less leveraged than other ownership vehicles, to the riskiness was usually minimal.

A tthe peak, in 2007, the REIT universe had an aggregate investment of 7.6% of undepreciated assets in the development pipeline, or a total of $34 Billion.  By March 31, 2012 (the cut-off for data in the Fitch report) that had collapsed to 2.7%., and indeed over a third of that is in the fundamentally sound apartment market.

Fitch summarizes the market as “fairly muted”, and says that “By and large, companies have not ramped up development pipelines,” according to Steven Marks, managing director at Fitch in a follow-up interview to Globe Street.  “It is really growth via acquisitions and organic cash flows from existing portfolios.”

The report also noted that over the past 10 years, REIT development activities have had a high correlation with U.S. GDP changes.  Thus, improvements in U.S. GDP would signal development opportunities for REITs, but continued stagnation in the U.S. GDP suggests that REITs will continue to remain quiet on the development front.

Written by johnkilpatrick

July 16, 2012 at 8:10 am

October 10 — Update #2

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Since my last post, I also had the privilege of attending (and speaking) at the semi-annual meeting of the Real Estate Counseling Group of America (RECGA). RECGA is a small but highly influential group, founded in the 1970’s by the great real estate valuation leader, Dr. Bill Kinnard, and over the years has counted in its membership many of the presidents of the Appraisal Institute and other leading groups, editors of several of the top real estate journals, noted professors and highly influential authors in the field.

The Fall meeting was held in Washington, DC, and the core of the meeting was Friday’s educational session. Max Ramsland opened up with a presentation demonstrating the impact of the number of anchor tenants on the appropriate cap rate of shopping centers. Carl Shultz, a member of the Appraisal Standards Board, followed with a discussion of impending changes to the Uniform Standards of Professional Appraisal Practice (USPAP). These changes are currently discussed in an Exposure Draft, which he invited RECGA members to revieww and submit comments about, and will be incorporated (with appropriate changes) in the 2012 edition of USPAP. Both Mr. Ramsland and Mr. Shultz are also RECGA members.

Two non-members followed with somewhat related presentations on eminent domain. Scott Bullock from the Institute for Justice was one of the attorneys who argued the famed Kelo case before the U.S. Supreme Court, and he discussed the status of eminent domain law since that landmark case. With a somewhat different perspective, we heard from Andrew Goldfrank, a U.S. Justice Department attorney who heads up all Federal takings litigation.

The afternoon session kicked off with David Lenhoff, a RECGA member and former editor of the Appraisal Journal, who discussed the complex issues surrounding hotel valuation. I followed with a brief synopsis on the Gulf Oil Spill, focusing on the current status of the claims and litigation processes. Reeves Lukens, a RECGA member, and his son, Tripp Lukens, discussed the state of pharmaceutical properties in the U.S. Joe Magdziarz, who is the incoming president of the Appraisal Institute (AI) discussed the current issues facing that organization, with a particularly emphasis on the recent controversies between AI and the Appraisal Foundation (AF). Notably, the founding Chair of AF, Jeff Fisher, is a RECGA member and was able to provide some historic commentary. RECGA members Jeff Fisher and Ron Donahue brought the day to a conclusions with discussions about the state of the securitized real estate market, including REITs.

For more information about RECGA, visit the web site,

Written by johnkilpatrick

October 10, 2010 at 11:24 am

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