SAN FRANCISCO -- This year, the pockets of the attendees of the annual National Association of Real Estate Investment Trusts convention looked a little fatter, and it was hard to find a face without a smile.
That should really be no surprise, given that the REIT stocks are up 27% this year, based on the U.S. MSCI REIT index, and are set to beat the broader indices for the seventh straight year.
With the huge amount of capital flowing into the space from private equity and pension funds, it was hard for most industry participants at the conference to imagine any sort of
meaningful correction in the space, despite recent earnings disappointments from the likes of
General Growth Properties
"Who knows, maybe this big love fest will end ugly?" says one buyside investor. But it's not likely, he says. After all, REITs are nowhere near as volatile as tech stocks and "getting wiped out," as he says, is not a real possibility. (This is largely because these companies own commercial real estate buildings that are worth a lot of money on the private market.)
Expecting 25% annual returns in the sector is foolish. But investors can reasonably expect 10% annual returns going forward in the sector, says David Lee, a portfolio manager with T. Rowe Price. This forecast assumes 7% earnings growth and a 3% dividend yield -- and also assumes that multiples hold in the sector.
The good news for REIT investors is that fundamentals remain great for commercial property, and there is still so much money out there chasing the "yield plus" returns that real estate and REIT stocks offer.
William Karnick of Colony Capital, a real estate private investment firm, said private equity is set to raise $300 billion to $400 billion (after leverage) of money this year that will be invested only in real estate.
Jon Fosheim, CEO and co-portfolio manager with Oak Hill REIT Management, said this glut of capital will probably sustain valuations in the sector for now.
At some point, though, the party ends, Fosheim said. This will occur when junk bonds go back to their normal risk premiums above Treasuries, he explains. The fact that junk bonds can be issued at such low spreads today helps fuel the easy money that private equity shops use to take REITs private.
Eventually this game will end, but no one knows when.
Christopher Hartung, a real estate investment banker with Wells Fargo Securities, said this easy credit flow could end if the
gets worried about banks' balance sheets and forces lenders to strengthen their underwriting criteria.
Today, it's not unusual for banks to underwrite negative leverage deals, where first-year property income doesn't cover debt expenses (rather, over the long haul, as rents rise, property income will cover the debt).
Hartung pointed out that if banks become more stringent on underwriting, then leverage will no longer be so easy or cheap to obtain, which will stifle property sales.
At that point, REIT investors will be forced to examine the true NAV of stocks because there aren't enough transactions in the market to evaluate, he said. NAV, net asset value, is a metric that measures the underlying real estate value of REITs by using private market valuations.
If the debt market unravels, public REIT stocks will get repriced downward, and possibly very fast, he said.
Nonetheless, absent any sort of meltdown in the capital markets, any near-term REIT correction only represents a buying opportunity for the funds that manage institutional money that is earmarked for real estate.
One buyside source who manages over $20 billion of REIT money told
that if the sector falls 10% from here, his fund will be buying in droves.
This is a sentiment that James Keagy, managing director of Barclays Global Investors, echoed on a panel discussion. He said institutional investors will continue to buy REITs on the dips, which will have a moderating effect on prices.
The other matter giving everyone some comfort is that fundamentals still look very good across most property sectors. However, recent earnings results have showed that not every REIT is equal -- and many conference participants agree that it could become more of a stock-picker's game going forward.
"All REITs are not created equal," said Don Wood, CEO of
Federal Realty Trust