For investors who feel the worst may be over for real estate investment trusts, or REITs, some discouraging news: A literal flood of your favorite REIT's stock may hit the market between now and March of next year. The culprit isn't anything new. Rather, it is a 2-year-old flame that may again burn REIT investors -- the unit investment trust, or UIT.
In late 1997, a host of Wall Street firms began to offer investors a diversified and inexpensive way to play the hot REIT market -- unmanaged baskets of REIT stocks without a commission or the load typically charged on a sector mutual fund. In all, between December 1997 and mid-1998, 13 REIT UITs were launched with a collective market value of more than $4 billion.
While the firms offering the products lauded them as a way to help individual investors invest in real estate, other analysts in the sector
suggested that the UITs were self-serving, rife with conflict and poorly timed. As it turns out, the doomsayers were right. As one buy-side analyst put it, "I hate to say, 'I told you so,' but ... It was the best signal of a top to a sector I have ever seen."
Unfortunately, the worst may be yet to come. That's because unlike perpetual, open-end mutual funds, UITs have a fixed termination date when the trusts are required to liquidate their holdings and pay the proceeds to investors. While UIT liquidations are not typically a significant event, for the relatively illiquid REITs held in many of these trusts, the flood of supply to the market at sinking prices could be enough to further depress the shares.
Unleashing a Flood
Of the 13 UITs on the market, five mature between December and the end of March 2000 and represent over $650 million in original value. Three firms issued the trusts, including two each from
, and one from
This group of UITs, in particular, has suffered from performance woes. Of the five, the average total return since inception is nearly 15%, compared with a loss of 6.6% for the
SNL Equity REIT Index
, which also includes dividends. This has meant a slow but steady leaking in the size of these REITs, as investors choose to cut their losses. David Fick, a REIT analyst with Legg Mason, estimates that this has meant a significant shrinking. "As a whole, REIT UITs have bled out about half of their holdings," he says. "It's clearly a result of the performance of the sector."
The continued leak of shares from the UITs has put pressure on companies participating in the trusts. "There is no question that the trickle
from UITs has hurt the sector," Fick says, "and until all of the UITs are gone, that's not going to go away." The final UIT doesn't mature until April 2002, and the bunch includes a $1 billion offering from
Cohen & Steers-Merrill Lynch
, which matures in April 2001.
The more immediate concern is the looming liquidation of the five UITs over the next five months and the shares of the companies likely to be most affected. Even considering premature liquidation of between one-third and one-half of the original portfolios, several companies could face the equivalent of a week's worth of volume hitting the markets from the terminations.
"If you have a week and a half of supply hitting the market, obviously that will account for some selling pressure." -- Larry Raiman, DLJ
"The impact on better-known companies should be minimal," says one buy-side analyst who asked for anonymity, referring to such large-cap names as
Equity Residential Properties Trust
Simon Property Group
. "However, the smaller companies in out-of-favor sectors could get crushed. Take
for example. Nobody wants that stock. You put 250,000 shares on the market and the price could fall 15% or more."
Larry Raiman, head of REIT research at
Donaldson Lufkin & Jenrette
, suggests measuring a REIT's potential exposure by comparing the number of shares outstanding in UITs to the average daily volume in the stock. (See table below.) The longer it will take the market to absorb the new supply, the bigger the threat to existing investors. "If you have a week and a half of supply hitting the market, obviously that will account for some selling pressure."
Data from a
midyear 1998 report indicated that three REITs had more than 10% of their total float tied up in the 13 existing UITs:
(11.6% of shares owned by REIT UITs),
Brandywine Realty Trust
Not everyone agrees that the terminations will be the end of the world. "Most REITs aren't in a mode where the current cost of capital is meaningful to them," says Chris George of
, a former
real estate analyst. But as even he admits: "They are painful to look at and psychologically damaging. This is just one more reason REITs are likely to continue to languish. There is an incredible despondency toward the sector."
An Expensive Lesson
All this has many REITs that elected to participate in the UITs fuming. While none wanted to be identified, many were quick to say they felt pressure to participate. "We got our arms twisted to participate in the Cohen & Steers-Merrill Lynch deal," says one REIT executive. "They applied way too much pressure. We should have taken a closer look." Many REITs specifically cited the Cohen & Steers and Merrill offering as a high-pressure affair. Calls to Cohen & Steers and Merrill Lynch were not returned.
One sell-side analyst said the pressure was overwhelming, with implicit threats to both investment banking and research opinions. "Companies were told to participate or their banking relationships were in jeopardy," he says. "I also know research was in play. If you have coverage, it could be at risk, and if you were seeking coverage, a decision not to participate meant 'forget it.' "
The problem doesn't lie with UITs per se. "The UIT is not necessarily a bad vehicle," says
Christopher Marinac. "What's important is the value to the company that participates. Many companies resisted the pressure to participate. But for those that did
participate, it was a very expensive lesson."
A lesson they, and their investors, continue to relive every day.
Coming next, a preview of this week's
National Association of Real Estate Investment Trusts
annual meeting in Los Angeles and the gathering of the
TSC REIT Roundtable
If you have a question you think is worthy of our experts on the Roundtable, don't be shy: Shoot me an
email with your toughest query and we'll put it before them. And, for the three of you with the cleverest questions (as chosen by the experts themselves), a little
trinket will be headed your way. So give us your best shot!
Gary B., by the way, despite this weekend's losses, it's the
in six. Don't get me wrong: I love the
and fundamentally they may be the better team, but it's clear the Braves formed a double-bottom over the weekend and should rocket back in six. Whatever.
Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback at