REIT Shares Ripe for Slowdown

As the REIT industry gathers this week in Chicago for the annual National Association of Real Estate Investment Trusts convention, the mood will be more subdued than in past years.

Earnings misses, interest rate fears and concerns over expensive valuations have dragged down the sector in recent weeks, leaving investors to wonder if the magnificent bull run that REITs have enjoyed over the past five years is coming to an end.

Ever since the tech sector imploded in 2000, REITs have trounced the broader market. Individual investors flocked to the sector as commercial real estate was viewed as a safe investment that paid healthy dividends on their 401(k) and IRA dollars.

However, during this time, something interesting occurred. Huge bundles of money flowed into the sector, while earnings growth for equity REITs (those that don't primarily invest in mortgages) remained minimal.

In 2004, equity REITs as a group posted a 32% total return. However, the group's funds from operations -- a key profit measure for REITs -- rose by just 3.2% on a per-share basis, according to SNL Financial, a real estate research firm. In 2003, the industry posted a 37% total return while FFO grew 2.2%.

The concern nowadays is that investors will no longer pay substantial premiums for REITs' minimal earnings growth.

"Two years of 30% returns in a row are a huge anomaly," says Lou Taylor, a longtime REIT analyst with Deutsche Bank. "The group on a long-term basis is low-double-digit [annual total returns] with half of that in terms of yield."

Taylor says the biggest issue facing REITs is competition from the rising yield on the two-year Treasury note, a risk-free investment that is currently yielding 4.4%. The average current dividend yield for equity REITs is 4.7%, down from 7.6% in 2000, according to SNL. Some REITs, such as Simon Property Group (SPG), have yields as low as 4%. As REIT yields drop and the two-year Treasury yield rises, money flows are being affected, Taylor says. "It's attracting money into the money market and bond funds."

REIT Total Return Performance
Index Total Return	YTD*	2004	2003	2002	2001	2000	1999
Industrial	5%	31%	33%	17%	7%	33%	4%
Multi-Family	11%	35%	26%	-6%	10%	35%	10%
Office	9%	22%	33%	-4%	5%	36%	1%
Regional Mall	9%	46%	54%	25%	30%	19%	-15%
Shopping Center	2%	36%	42%	16%	29%	20%	-12%
Hotel	0%	33%	30%	-1%	-6%	43%	-22%
All Equity REIT	7%	32%	37%	4%	14%	26%	-5%
Russell 3000	1%	12%	31%	-23%	-13%	-9%	19%
DJIA**	-4%	3%	25%	-17%	-7%	-6%	25%
S&P 500**	-1%	9%	26%	-23%	-13%	-10%	19%
NASDAQ**	-4%	9%	50%	-31%	-21%	-39%	86%
Source: SNL Financial *Year to date as of Oct. 31 **Price change only