Despite consistently having generated above-average returns during much of the past six years, industrial real estate investment trusts, especially those with a global reach, are slipping along with the economy.
Prologis, based in Denver, and AMB Property Corp., headquartered in San Francisco, had led the pack, having delivered total annual re-turns, including dividends, of 24.98% and 20.99%, respectively, on average from 2003 through 2007. This outpaced the Standard & Poor's 500 stock index, which rose 12.8% annually on average, and equity
REIT returns, which averaged 16.6% annually during the same period, according to the National Association of Real Estate Investment Trusts in Washington.
Despite the stellar past performance, investor enthusiasm soured this year: As of the close of business Aug. 27, Prologis' return was -30.7%, while AMB had declined 21.7%. This trailed equity REITs, which were down 0.25%, and the S&P 500, which was down 12.7%.
Concerns about the slowing global economy and the companies' abilities to build and lease new developments in these markets triggered the sell-off.
"We see trends likely deteriorating into 2009," Jonathan Habermann, an analyst at
Goldman Sachs & Co. Inc. of New York, wrote in a note.
This year, economists speculated that the global economy wouldn't be dragged down by the downturn in the United States. As a result, market analysts speculated that companies that were active overseas and generated a healthy chunk of their earnings in foreign markets would flourish.
But in recent months, the global economy has started to founder. Gross domestic product growth turned negative in the second quarter in both Europe and Japan, with GDP falling 0.2% from the previous quarter in Europe and 0.6% in Japan, said Bob Bach, chief economist with Grubb & Ellis Co., a commercial real estate services and investment company based in Santa Ana, Calif.
"They are very large development organizations and have business models that generate earnings based on development and development margins at a time when things are slowing," said Joe Smith, managing director and portfolio manager at ING Clarion Real Estate Securities of Radnor, Pa. "Long-term, it's a great business model," but in the near term, it poses risk, he said.
A global economic slowdown will affect global trade, which in turn will hurt demand for industrial space, Mr. Bach said. The recent sell-off of Prologis and AMB reflects this concern.
"Investors are looking ahead and anticipating," Mr. Bach said.
"Industrial tends to be [affected] by the GDP and the shipment of product," said Rich Moore, an analyst in the Solon, Ohio, office of New York-based RBC Capital Markets.
Indeed, the same attributes that drove the industrial REITs' stalwart performance in recent years — heavy development activity and global expansion — are now dragging down investor sentiment to-ward the companies. Prologis, AMB and, more recently, First Industrial Realty Trust Inc. in Chicago, had been expanding globally to offset the slowdown in the U.S. industrial market, where the vacancy rate hit its highest level in three years in July.
And even though most REITs have hefty development pipelines to drive growth, analysts and other industry experts are cautious about this business model — and probably will be for the next six to 12 months.
Mr. Habermann noted that Prologis fell short of analysts' expectations in the second quarter, and indicated deteriorating trends in net operating income growth, occupancy, rents, leasing activity and development margins.
"Industrial fundamentals are slowing at a more rapid pace than we had originally expected," he said.
Although Prologis reaffirmed its 2008 earnings guidance, Mr. Habermann expects business to slow into 2009.
"Global economic data continues to point to an outlook that is decidedly murkier," Michael Bilerman, an analyst for New York-based
Citigroup Global Markets Inc., wrote in a research note. He estimated that AMB and Prologis get between 40% and 65% of their earnings from their merchant development businesses.
"We see this as a key risk to both stocks," given the slowing global economy and falling real estate values, Mr. Bilerman wrote.
Still, some industry experts wonder whether the stock sell-off may be overblown. Mr. Moore said that the companies' earnings will likely start to contract, but he doesn't think that the companies will chalk up losses.
"They may grow at a slightly slower pace than they had, but they're not going to go negative ... and there's no reason to think they're going to fall completely out of bed," he said.
According to Mr. Smith, industrial REITs offer a good business model in the long term.
"But unfortunately, we get graded every month, and we have to think about the economy and how different companies' businesses will react to the economy," he said. "We're cautious on any business that's a developer right now, because things are slowing" both domestically and globally.
Mr. Smith sees demand for industrial space slowing over the next six to 12 months.
E-mail Janet Morrissey at [email protected].
